PCAOB’s Role in Enhancing Public Trust and Integrity in Audits

Let me begin by stating that the views I express are my own and should not be attributed to the PCAOB as a whole or any other members or staff.

It is a pleasure to join you for the 44th year of this conference. In addition to the technical training on current and emerging issues the conference provides, it is an important opportunity for those who care about the accounting profession to reflect on the profession's future in our markets.

I believe the profession has a bright future. Society's needs for assurance are expanding, and I believe the profession is now well-positioned to meet them.

But it is not a routine business opportunity. It depends on the profession's continuing to attend to society's needs.

Since the dark days of Enron and the many other accounting scandals that followed it, both the profession and the PCAOB have worked hard to reestablish the profession's footing solidly in the public interest.

The PCAOB is founded on an idea that is as compelling today as it was in 2002. Establishing an independent, expert, dedicated audit oversight organization – outside the government but overseen by the SEC – would shore up the critical role of the audit in our markets.

In my time today, I will cover four themes underlying this idea, to explain how the PCAOB helps provide the profession that solid footing needed to maintain and grow public trust.

  • First, investor protection is enhanced by an independent process that promotes the integrity of audits.
  • Second, the PCAOB plays a vital role as a mechanism for not only managing that process but making a real difference.
  • Third, forging a constructive relationship with firms, albeit a somewhat adversarial one, benefits our economic system, protects investors, provides clarity on essential standards, helps companies stay on track and contributes to capital formation.
  • Finally, the PCAOB can be a catalyst to help the profession achieve the full potential of its role in our capital markets. We know a rapidly changing landscape will require the PCAOB to sustain its investment in innovation, in order to meet the needs of investors and enable public companies in our markets to benefit from a lower cost of capital.

In all this, the wisdom of the great English conservative thinker, Edmund Burke, comes to mind – "He that wrestles with us strengthens our nerves and sharpens our skills."

I think Burke would have understood the critical role the PCAOB plays, through independent oversight and review, in strengthening the profession.

Before I talk about these themes in more detail, let me tell you about the priorities we addressed in 2016, a very busy year.

We continue to do more in the way of outreach, especially to audit committees, with a view to help raise awareness of audit risks and challenges. We issued a report on inspection observations since 2013 related to audit firms' communications with audit committees.

We've met with preparers and auditors to understand challenges they have faced in audits of internal control over financial reporting.

We have worked with audit firms to implement our new standard on disclosure of the name of the engagement partner and other firms involved in an audit. Those disclosures will begin to be available to investors and markets in 2017.

In April, we proposed a new standard on using the work of other auditors. In May, we issued a revised proposal on improvements to the auditor's reporting model, reflecting changes in light of comments received on the original proposal.

All the while, we've made significant strides in developing and implementing an improved standard-setting process, providing for deeper research before embarking on new projects as well as enhancing outreach at all stages.

In this regard, we've held public meetings with our advisory groups on the auditor's reporting model, audit committee interaction, use of non-GAAP measures, and on various performance standards such as the use of other auditors, specialists, estimates and fair value measurements.

We've also devoted considerable effort to build our capabilities in research and economic analysis, through our Center for Economic Analysis.

Center economists are using economic analysis to judge the impact of new rules and standards, both ex ante and ex post, by applying empirical skills to data collected both publicly and through our inspection program.

By improving our economic analysis of standards under development, we can have greater confidence that the benefits of those new standards will justify their costs.

We issued a request for public comment on the Center's first-ever post-implementation review of a standard we issued several years ago to improve engagement quality reviews.

Center economists are also evaluating many of the potential audit quality indicators that we vetted publicly in a concept release last year, by aggregating firm data obtained in inspections and conducting empirical tests across firms.

We have also posted working versions of eight research papers by distinguished Center scholars on our website. They are undergoing rigorous peer review and may be subject to some change. But they give you a sense of what the PCAOB can, and I believe must, do to understand the motivations and impediments to audit quality.

We have issued staff inspection briefs previewing 2015 inspection findings and the scope and objectives of the 2016 inspection cycle.

We issued a fifth annual inspection report on our temporary broker-dealer program. We've used the growing body of information accumulated in these inspections, and the insights they've afforded, to develop a proposal for a permanent program for public comment.

Internationally, we secured renewal of the European Commission's adequacy determination, which allows us to continue to conduct joint inspections of PCAOB-registered firms with European audit oversight bodies. The renewal runs for another six years – double the period of previous such determinations.

Last week, we announced a protocol for joint inspections with Italian authorities. There remain just a handful of jurisdictions where we need to but can't yet inspect PCAOB-registered firms – Ireland, Belgium, Portugal and China. We are well along in achieving protocols in the first three, and we continue dialogue with authorities in China.

Where appropriate, we have commenced deeper investigations and disciplinary proceedings. We have experienced a significant increase in enforcement matters relating to potential violations by registered non-U.S. firms.

The PCAOB announced settled actions in two of these matters today: one involving materially false audit reports by the Brazil office of a large firm network, the other involving an audit failure by the same network's Mexican office.

In addition to the cases announced today, we made public 47 settled disciplinary proceedings, which exceeds the number of actions announced in 2015.

Our litigated proceeding are non-public, but I would like to note that the United States Securities Exchange Commission earlier this fall upheld the PCAOB's sanction against an audit partner for failing to address deficiencies in his audit of the U.S. subsidiary of an Israeli-based foreign private issuer. We continue to have an active docket of non-public matters involving a range of issues and firms.

Addressing the conduct of bad apples not only protects investors, but it protects you as well. Who among you hasn't, at some point in your career, worked for or along with, or observed, someone you felt put you at risk through careless work or, worse, by simply acceding to aggressive reporting for a career or economic benefit.

The heads of several of the PCAOB's divisions and offices will speak in detail about this work over the course of the next three days: Chief Auditor Marty Baumann, Director of Inspections Helen Munter, and Enforcement Director Claudius Modesti. You'll also hear from my colleague on the Board, Jay Hanson.

None of it would be possible, though, without the support and counsel of the SEC Chair and commissioners, as well as staff in the Office of the Chief Accountant, particularly Chief Accountant Wes Bricker and Deputy Chief Accountant Marc Panucci, who spoke to many of these initiatives this morning.

And I know I speak for all of the PCAOB in wishing former Chief Accountant Jim Schnurr well in his continuing recovery.

The work I described reinforces the four, fundamental themes I referred to at the beginning.

Theme number 1: Investor protection matters, and it is enhanced by auditor oversight

It is the flow of certified information in the marketplace that, when perceived as both reliable and relevant to investment decisions, gives uninformed and dispersed investors the confidence to participate in a market as great as that which we enjoy in the U.S.

The U.S. federal securities laws emanated from our strategic desire, as a nation, to bolster public confidence in our capital markets for the purpose of restoring and enhancing our ability to form capital for private enterprise.

Without concerted effort to maintain and champion a vigilant system of validating the financial information provided to the market, our businesses pay more than they need to for funding.

The long term stability of our capital markets and the audit profession's important role in those markets depends on uncompromising trust. That trust, once lost, cannot be easily regained.

If long-term investors don't have a basis for trust in a company's statements about its position and plans, short-termism may become the dominant market mentality, stifling innovation and job creation, and, ultimately, hindering economic growth. The PCAOB protects against such erosion.

Theme 2: The vital role the PCAOB plays as a mechanism for managing that process is making a real difference

In my view, our independent oversight has changed the landscape for the better.

Inspections have improved audits, and changed firms' attitudes and execution. Some of that emerging research I mentioned indicates that when we find deficient audits, the engagement teams raise their game – without a commensurate increase in fees but with a statistically significant reduction in restatements.

Issuance of regular inspection reports provides meaningful information that didn't exist before, and that helps all parties, including investors, audit committees, and companies, make better decisions.

Enforcement has helped root out bad apples, and fosters trust in the system. Boards can use our published cases to gravitate to better auditors and better audit practices.

We have issued better and clearer audit standards related to the performance of audits. We have also made progress in improving the relevance and transparency of audits.

Awareness of our role and mission is now firmly established, and emerging academic research suggests this is helping build public confidence in investing.

It is my belief that the PCAOB has a unique and indispensable role in helping companies maintain investor trust, avoid financial reporting failures, and in turn has helped our economy and capital markets remain resilient and grow.

Theme 3: Our intent is to forge a constructive relationship with the profession that benefits our economic system, protects investors, provides clarity on essential standards, helps companies stay on track

In the PCAOB's 14 years, our inspectors have examined many thousands of audits and found numerous examples of high quality auditing, including evidence of auditors requiring companies to adjust their accounting or improve their internal controls over financial reporting. These auditors are the unsung heroes who avert the scandals that don't happen.

But our inspectors have also found and reported numerous instances in which firms' audit reports should not have been issued.

No one likes a restatement, but when a material misstatement is identified, an early correction is better for both the company's investors as well as the company's reputation, and related cost of capital.

The more audits we can review, the more likely the prospect of scrutiny will deter the kind of audit failures that led to the Sarbanes-Oxley Act. This was the organizing principle underlying the creation of the PCAOB, but now we've put it to the test and demonstrated that it's true.

Theme 4: As a catalyst to help the profession achieve the full potential of its role in our capital markets, we know a rapidly changing landscape will require the PCAOB to sustain our investment in innovation. That informs our analysis of the work that lies ahead

There are four topics under research in our new standard-setting process. None should be surprises, for they have all been on our agenda for some time.

They include potential improvements to our quality control standards.

Audits also need to take advantage of technology to glean more insights about risks and help focus resources on important areas for follow up. We will study how new tools can best advance investor protection.

We will also continue to monitor the auditor's association with non-GAAP data, especially data purportedly derived from the audited financial statement.

And we will give focused attention to the auditor's responsibilities under the Private Securities Litigation Reform Act of 1995 related to potential illegal acts.

The PCAOB is also nearing completion of a project to make the auditor's report more useful and informative to investors and other financial statement users.

This project emanated from Treasury Secretary Paulson's Advisory Committee on the Audit Profession, which published a number of recommendations in the fall of 2008, including that the PCAOB improve the usefulness of the auditor's report.

Through PCAOB outreach, investors have confirmed the importance of retaining the binary, pass-fail opinion. But in today's complex economy, and particularly in light of lessons learned after the financial crisis, users of the audit report also want a better understanding of the judgments that go into an opinion.

After reflecting on public comment received on a concept release, in 2013, the PCAOB proposed a framework for auditors to report such "critical audit matters."

In the intervening years, there has been promising experimentation with similar frameworks abroad, including by the profession itself through the International Auditing and Assurance Standards Board, which in 2015 adopted requirements similar to those we proposed – to elucidate "key audit matters" in the audit report.

There has been positive reaction to these changes from a broad range of market participants, including securities issuers themselves, who have seen expanded audit reports as a tool to signal commitment to high quality and reliable financial reporting.

Investors have also welcomed the more insightful reports. One experienced institutional investor said there's finally "an audit report worth reading."

Auditors, too, enjoy renewed relevance and vitality. The head of one large U.K. firm's audit practice testified at a PCAOB hearing that in "20-odd years of auditing," he had never seen so much "interest from investors in what I'm doing." The change, he said, was "a real positive."

Those are strong testimonials. Earlier this year, we refined our proposal, in light of public comment as well as a robust economic analysis.

Although more modest than some other jurisdictions' requirements, it is a step that will allow companies to distinguish themselves by retaining auditors with track records for more insightful and reliable reports, and will allow auditors to compete to serve such clients on the basis of the quality demonstrated in their reports.

In closing, underlying all the PCAOB's initiatives is the goal to help the profession meet increasing demands in a responsible way that preserves integrity, inspires investor trust and promotes economic vitality.