Remarks for the U.S. Chamber of Commerce Virtual Event

Thank you, Evan. I am delighted to be here with you today because we share the same regulatory vision where we both believe that “[g]etting [the] balance of [regulations] right is essential to driving solutions that improve lives and fostering a vibrant and dynamic economy that creates opportunities for people.”¹ But before I begin in earnest, I need to say the required PCAOB disclaimer. The views I express here are my own and do not necessarily represent the views of the PCAOB Board, other Board Members, or PCAOB staff.

I consider it a privilege to express my views, especially since I have been the lone dissenter on some recent PCAOB rulemakings. I came to this country over 30 years ago from Macau in pursuit of a good college education, opportunities, and freedom. I grew up in a culture where girls were taught to conform and keep quiet. However, I was blessed to have parents who gave me the freedom to think independently and to express different views. My first act of civil disobedience was joining the organized demonstration in Macau supporting the student-led 1989 democracy movement in Beijing’s Tiananmen Square which ended in the Chinese Government’s declaration of martial law and its massacre of innocent, freedom loving students in Beijing on June 4, 1989, almost 35 years ago a week from today. I was a high school junior at the time. Although it might have been perceived as dangerous or useless, I felt a need to show solidarity with those courageous college students. It was during those early years that I began to understand and appreciate the importance of the democratic norms that underpin the great American Experiment launched by Thomas Jefferson with the Declaration of Independence. And it is our democratic norms that underpin my willingness to dissent, when necessary, even though the easier course is to acquiesce to the views of the majority. As Hubert H. Humphrey said, “Freedom is hammered out on the anvil of discussion, dissent, and debate.”

One area where our body politic could benefit from more discussion and debate is on regulations, and I am delighted today to share my views which consist of the following three pillars: (1) regulations should only be adopted when necessary; (2) regulations should be well-designed and in proportion to the problem to be solved; and (3) regulations should facilitate trust and innovation. 

Pillar One – Regulations Should Only be Adopted When Necessary

Why is there so much regulation if the marketplace is the most effective regulator of economic activity? One answer might be that markets are not always perfect. For example, in an unregulated market, companies may not have incentives to provide investors with accurate or complete information needed to make informed investment decisions. Regulation might be needed to require disclosure of information, and this is why today we have securities laws. After the stock market crash of 1929 and after banks began to fail (federal deposit insurance did not exist until after the FDIC was established in 1933), individuals began to hoard their cash and America’s economic engine ran out of gas. Government regulation proved necessary. In FDR’s signing statement for what became known as the Securities Act of 1933, he said:

“Events have made it abundantly clear that the merchandising of securities is really traffic in the economic and social welfare of our people. Such traffic demands the utmost good faith and fair dealing on the part of those engaged in it. If the country is to flourish, capital must be invested in enterprise. But those who seek to draw upon other people’s money must be wholly candid regarding the facts on which the investor’s judgment is asked. To that end, the Bill requires the publicity necessary for sound investment. It is, of course, no insurance against errors of judgment. That is the function of no Government. . . .”²

This new regulatory structure provided a solid foundation for capital formation to occur. A SEC Commissioner recently stated, “the initial set of federal securities laws passed by Congress ninety years ago during the Great Depression have held up well. . . . Congress chose to rely on market mechanisms, while addressing information asymmetries through disclosure. This approach provided the foundation for the subsequent success of the U.S. capital markets to date, which facilitate capital formation and the resulting prosperity from economic growth, jobs creation, and innovation.”³

Fast forward to the early part of the 21^st century when there were a series of bankruptcies of major U.S. corporations stemming from accounting and auditing failures. Perhaps the most prominent bankruptcy was when Enron filed in December 2001. It was also the largest bankruptcy in U.S. history. The Enron bankruptcy plus others led to billions of dollars in losses for investors, shaking public confidence in the U.S. capital markets.⁴ At that time, the public accounting profession was largely self-regulated. Just as Congress acted in 1933 in response to a wide-spread loss of confidence in the U.S. capital markets, Congress acted in 2002 in passing the Sarbanes-Oxley Act of 2002 (SOX). The Senate Report describes its purpose as follows:

“The purpose of the bill is to address systemic and structural weaknesses affecting our capital markets, which were revealed by repeated failures of audit effectiveness and corporate financial and broker-dealer responsibility in recent months . . . .”⁵

And as you know, SOX established the PCAOB and ended self-regulation of the auditing profession.

So what’s my point? To paraphrase former Federal Reserve Board Chair Ben Bernanke, although the free-market system is the principal source of America’s economic dynamism, history suggests that targeted government intervention and regulation can be beneficial to our capital markets system and to investor protection.⁶ Now, Chair Bernanke recognized that the benefits of regulation also come with direct and indirect costs, which brings me to my second pillar.

Pillar Two – Regulations Should Be Well-Designed and in Proportion to the Problem to Be Solved

Regulations carry with them potential disadvantages in the form of costs, which can be substantial, if not proportionate to the problem to be solved. Poorly designed regulations can give rise to unreasonable compliance costs that impede companies’ ability to invest their scarce capital in research and development or job creation. One way to distinguish between regulations that do “good” on the one hand and those that do “harm” on the other hand is through a careful evaluation of their benefits and costs. 

In May 2022, the PCAOB announced an ambitious standard-setting agenda. In its 2022-2026 Strategic Plan, the PCAOB declared that it “will improve audit quality by adopting [auditing] standards that are clear and scalable, to account for differences in the complexities and sizes of firms and the public companies . . . that they audit.”⁷ This excerpt is important because: (1) it is sensible; (2) it is consistent with the PCAOB’s statutory investor protection mandate which I believe the PCAOB can best fulfill by ensuring audit quality; and (3) it recognizes differences between and among audit firms. 

Unfortunately, the standards and rules the PCAOB has proposed or adopted over the past two years have increasingly fallen short of being sensible and consistent with our investor protection mandate, because they are poorly designed and will in the long-run harm investors by: (1) reducing audit quality and competition, and (2) increasing audit fees. Three in particular come to mind.

First, almost one year ago, the PCAOB proposed amendments to auditing standards related to a company’s noncompliance with laws and regulations. I dissented along with my fellow CPA Board Member DesParte whose term expired last October. I noted that the proposal contains a breathtaking expansion of the auditors’ responsibilities by transforming the role of the auditor from providing reasonable assurance to performing management functions. I pointed out the economic analysis’ acknowledgement that the proposal would have a greater cost impact on mid-sized and smaller firms and expressed concern about creating additional barriers to entry for the smaller firms which investors can ill afford given the lack of competition in the audit market for large multinational public companies. In the face of strong opposition by the auditing profession, public companies, investors, and others, the PCAOB agreed, during a House of Representatives hearing in December 2023, to hold a roundtable on the proposal.⁸ The PCAOB held the roundtable on March 6, 2024, and it also re-opened the comment period through March 18, 2024. The PCAOB has received approximately 50 comments since it re-opened the comment period. This proposal now has the third highest number of comment letters in the history of PCAOB.

Second, on April 9, 2024, the PCAOB Board approved a Firm Reporting proposal that would impose additional reporting requirements on all registered firms.⁹ I noted that the proposal contains approximately 38 new reporting requirements or elements, and that its expansion of reporting requirements were poorly designed because they contain no clear and direct linkages to audit quality.¹⁰ I also was critical of the proposal’s economic analysis because it quantifies neither the increased reporting and recordkeeping requirements nor their estimated costs. 

If the PCAOB had estimated the costs at the outset, it would have helped me better understand whether the burdens are proportionate to the projected benefits. Instead, the proposal takes for the most part a one-size-fits-all approach. It is one thing for a large firm to comply with the proposal’s new reporting requirements as they are generally well staffed, but for smaller firms facing challenges as a result of the “accounting talent crisis” and tight audit deadlines, the proposal’s additional reporting requirements would re-direct scarce professional staff time away from performing audits to satisfying additional PCAOB reporting requirements that have no clear connection to audit quality. To put it another way, the PCAOB’s proposal carries with it opportunity costs that could end up hurting audit quality and the investors we are sworn to protect by forcing firms to spend more time reporting and less time auditing. The burdens could also cause smaller firms to exit the public company audit marketplace resulting in less competition and higher audit fees that are ultimately borne by investors. The comment period on the Firm Reporting proposal closes on June 7.

Third, on May 13, 2024, the PCAOB adopted Quality Control standards (referred to as QC 1000) for registered auditing firms conducting audits of public companies, brokers, or dealers.¹¹ At first blush, the final rule appears narrowly tailored by distinguishing between firms that actively conduct public company audits and firms that do not. 

Approximately 51% of PCAOB registered firms have not conducted an audit for a public company over the past five years. Some of these firms have never and might never audit a public company, but under the final rule they would have to design a QC system that complies with QC 1000 upon it becoming effective in December 2025. To its credit, PCAOB considered an alternative; specifically, the economic analysis considered allowing these inactive firms to defer having to design a QC system until an indefinite later point in time that would be triggered only if an inactive firm explores whether to accept a public company audit engagement. The economic analysis acknowledges that this alternative approach would reduce the costs to inactive firms, but then rejects it by stating: (1) inactive firms could reduce such costs by withdrawing from PCAOB registration; and (2) the alternative would not address the risk that firms could be unprepared to accept and conduct audits of public companies.

Why would we ever suggest to inactive firms that they de-register? How does having fewer registered firms enhance competition in the audit marketplace and protect investors. The answer is that it does not. It also makes no sense to require an inactive firm to incur costs to design its quality control system “today” when it might not seek a public company audit engagement until 1, 2, or 3 years from now, if ever. Any reasonable audit committee member, investor, and regulator should prefer that an inactive firm design its QC system closer in real time to when the firm pursues a public company audit engagement, because there is a big difference between designing a QC system under a hypothetical scenario and designing a QC system under an actual scenario. 

Moreover, by suggesting that inactive firms de-register, the PCAOB seems to harbor an inexplicable hostility toward these mostly smaller firms, if not the entire public company auditing profession. Audit firms apply for PCAOB registration for many different reasons. Some “need” to apply because they want to immediately conduct public company audits. Others apply for registration because they might want to audit public companies in the future, and being registered with the PCAOB removes a barrier to doing so. This is akin to Americans applying for a U.S. passport even though they have no immediate foreign travel plans, because holding a passport removes a barrier.

Pillar 3 – Regulations Should Facilitate Trust and Innovation

It is common knowledge now that the PCAOB has been laser-focused in carrying out its enforcement program. PCAOB rules and standards being proposed and adopted have also become increasingly prescriptive. Driving compliance is important, but mere compliance does not necessarily equate to audit quality. According to a research paper published in 2016 by Dr. W. Robert Knechel who has been publishing research on auditing for over 40 years, titled Audit Quality and Regulation,¹² “mere compliance is probably not a sufficient condition for creating economic value via an audit. That is, meeting standards without reducing the risk will have little economic value because the assumption that compliance equates to risk reduction may not hold in all circumstances or all levels of regulation. Ultimately, it is the degree of correlation between compliance and audit quality that will dictate whether negative unintended consequences will undermine the value of the audit.” The risk of an overly compliance-driven regulatory regime can result in the unintended consequence of auditors shifting focus to “checking the box” instead of delivering quality audits. The key differentiating factor of value in audits is highly dependent on professional judgment and expertise. As Dr. Knechel wrote, “Judgment simply cannot be standardized or regulated out of the process, and some attempts to do so may actually have unintended effects on the audit process. In the end, the irony of standard setting and regulation is that the quality of auditor judgment determines the quality of the audit but systematic efforts to make audit processes more standardized (less subject to judgment) may have the effect of reducing the quality of audit outcomes. Absent professional expertise, a professional service may have limited value.”

My first role at Treasury was running the U.S. Department of the Treasury’s auction operations where it sells U.S. Treasury marketable securities to finance the federal government. To put this into context, in 2023 Treasury issued about $22 trillion in Treasury marketable securities,¹³ 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. Every Administration has preserved these principles because transparency and predictability facilitate trust. These same principles should apply to audit regulations. They should be balanced and reasonable, not subject to the swings of the political pendulum, because constant changes in regulations are costly, bad for business, and bad for our capital markets and investors.

Lastly, I believe that regulations should enable innovation. With the advent of artificial intelligence (AI), the opportunity to improve audit quality and reduce costs at the same time has never been greater. AI is no longer mere hype and now has tangible regulatory implications, especially since the President issued the Executive Order on the “Safe, Secure, and Trustworthy Development and Use of Artificial Intelligence” at the end of October 2023,¹⁴ and the European Parliament formally adopted the EU Artificial Intelligence Act in March 2024. If there was any doubt or debate about how significant AI technology is and will be to the global economy, welfare, and liberty, these two significant actions put that debate to rest. In addition, the American public has already adopted AI technology in many aspects of their lives. For example, I wear a device that tells me everything about my health including my sleep performance, fitness, and stress level. Never have I felt so informed and empowered to take control of my own health. Most people I know have had some kind of voice generated AI at home for years. Similarly, I understand that many audit firms and issuers are making significant investments in AI and other technologies. In this area, I believe that the PCAOB has been forward-looking. Under Chair Williams’ leadership, the PCAOB announced the formation of the Technology Innovation Alliance (TIA) Working Group on November 30, 2022, and appointed me to be the chair. The TIA Working Group’s primary function is making recommendations to the PCAOB regarding how its programs might address the use of emerging technologies by auditors and financial statement preparers. We have been meeting since then and the recommendations are due to the PCAOB Board soon. I believe that these are some of the positive steps the PCAOB has been taking to promote innovation in audit quality.

Thank you for giving me this opportunity to discuss the rapidly changing landscape in public company auditing.