Statement on the Firm & Engagement Metrics Adopting Release - Will This Unusually Rushed Auditing Standard Suffer the Same Fate of the Auditing Standard 2?

Remarks as prepared for delivery

Introduction 

Thank you, Chair Williams. Our votes today are unprecedented. Never in the history of the PCAOB has the Board rushed to adopt new standards and rules in the middle of a historic transition to new SEC leadership, let alone adopt standards and rules that are not ready. The Firm and Engagement Metrics was proposed on April 9, 2024, and we received 46 comment letters. If adopted today, it will set the record for this Board as the fastest adopted standard which only took 226 days (7.5 months). The average number of days from proposal to adoption for the five standards adopted by this Board to date was 448 days (15 months), with an average of 32 comment letters. Essentially, although the Firm and Engagement Metrics proposal has over 40% more comment letters than the average of 32, it took half as much time as the other standards adopted by this Board. Political expediency is not evidence-based policymaking. Haste naturally harms work product quality, which will not escape any keen eyes.

In my statement on the firm and engagement metrics proposal,¹ I stated that I am a strong advocate for data transparency² and expressed support for standardized reporting that is accurate, helpful, and a good fit for its proposed use consistent with the Paperwork Reduction Act (PRA) principles.³ To reiterate, the PRA principles are designed to ensure federal agencies: 1) do not overwhelm the public with unnecessary or duplicative requests for information, and 2) facilitate decision-making based on high-quality data. The PCAOB is not subject to PRA as it is not a federal agency; however, if we were, I believe our standard-setting process here has failed to align with these principles.

I applaud the staff for considering some commenter feedback and reducing the proposed eleven metrics to eight, which includes the elimination of proposed metrics where I expressed concerns, for example Audit Resources – Use of Auditor’s Specialists and Shared Service Centers and Audit Hours and Risk Areas. Effective regulators should listen to key stakeholders to inform rulemaking. However, I am not convinced that PCAOB has taken comments from key stakeholders as seriously as it should since the majority of the commenters do not support the proposed metrics. In my analysis of the overall sentiment of comment letters, over 70% of commenters expressed concern. For example, many commenters expressed their opposition to the engagement level metrics and related public reporting. Yet despite this opposition, this adopting release includes six engagement level metrics.

Insufficient Evidence and Support From Investors and Audit Committees for the Adopting Release 

In my statement on the proposal, I mentioned that I used three questions to consider the metrics proposed. These same three questions have provided a framework for me to methodically consider this adopting release.

1. Will the information we are proposing to collect be accurate?

   
   A commenter conducted an Audit Committee Survey that cited “73% of audit committee members surveyed state there are potential challenges and limitations in interpreting proposed metrics, particularly in relation to measuring audit quality” and “82% cite concerns about data specific to their audit being publicly available.”⁴

   Another commenter questioned whether the metrics are unambiguous, whether the metric could be interpreted on its own without additional context, whether disclosure of the metrics would result in a behavioral change to improve audit quality, and whether the metrics would pose an administrative burden.⁵ To mitigate misinterpretation and comparability across firms, the adopting release attempted to allow context by including an optional narrative disclosure, while simultaneously handcuffing firms to a limited number of 500 to 1,000 characters. 1000 characters is about 150 to 200 words. That is the same length as the opening paragraph of my statement today. With technology like Artificial Intelligence, why even impose a character limit? ChatGPT 4.0 can handle over 4,000 characters at one time and Google Gemini 1.5 can handle over one million characters. Today’s adopting release prescriptively restricts firms’ ability to provide adequate context so that the metrics are easily understood and not misinterpreted by the users of this information. Such arbitrary restrictions do not reflect modern technological advancement and undermine the accuracy and quality of the information to be reported and ultimately published.
   

2. Will the information we are proposing to collect be a good fit for its proposed use?

   
   The foundational principle of all PCAOB standards is to protect investors by improving audit quality. A commenter states “[i]t is unclear whether disclosure of firm and engagement metrics will meaningfully increase auditor accountability beyond the existing sources of accountability. Therefore, what is the underlying problem that this proposal is trying to solve?”⁶

   As an example, the adopting release includes a metric for the Training Hours for Audit Personnel, which begs the question, how will the average annual training hours clearly be indicative of audit quality? Ironically for this particular metric, the economic analysis admits that “[o]verall, the academic literature provides mixed evidence regarding how auditor training relates to audit quality” yet this metric is retained in the final release. All CPAs have state required training requirements. For example, the Virginia Board of Accountancy states that “[a]ctive CPAs must complete . . . 120 CPE hours over a rolling three-year period, with a minimum of 20 hours annually.”⁷ Since training is mandatory across states for licensure purposes, this is redundant information which adds no value in ascertaining audit quality, much less investor protection.

   Our standards appear to be based on the proposition that more is better in terms of public company audit firm disclosures. Yet, the PCAOB does not believe that to be the case when it comes to soliciting public comment on its proposed standards and rules, because it only gives stakeholders a sixty-day comment period, which is particularly short given the PCAOB’s simultaneously proposed standards. Some commenters requested an extension of the comment period deadline, which the PCAOB ignored.⁸ Other commenters suggested that the PCAOB pilot test the final rules before adopting them. However, the economic analysis dismisses this alternative on the basis that the pilot would “likely be voluntary, potentially with a limited group of participating firms, which may not be representative of all firms” and points to skewed results that would limit applicability. I am supportive of a pilot study prior to adopting this final standard, particularly with engagement level metrics, to gain more insights on what would or would not be beneficial information to investors. But conducting such a pilot would take time, and while the PCAOB states that it is committed to getting its adopting releases right, actions speak louder than words and this midnight rulemaking demonstrates the hollowness of the PCAOB‘s rhetoric. This hollow rhetoric carries over to the economic analysis’ repudiation of a pilot because of a so-called limited participation problem, especially since there is a simple solution. Specifically, invite a representative sample of firms to participate. Given that commenters were the ones that suggested a pilot, I believe it’s safe to assume there would be plenty of firms interested in participating. And how would we know if we do not even try? The results of a pilot study would provide vital insights into developing standards that have actual utility and direct connectivity to audit quality. Instead, this standard adopts burdensome metrics that have an unproven correlation with audit quality.
   

3. Will the information we are proposing to collect be helpful to the targeted users?
   
   PCAOB points to audit committees and investors as the targeted users of these metrics. A commenter’s Audit Committee Survey cited that “[a]udit committee members surveyed largely indicated they currently have the information they need today.”⁹ Specifically, this survey found that:
   
• “95% of audit committee members surveyed say the information available to them to fulfill their external auditor oversight responsibilities meets most to all their needs.”
• “78% of audit committee members surveyed are concerned that mandated public disclosure of engagement-level performance metrics, including issuer name, could lead to unintended consequences and should be voluntary.”
• “80% of audit committee members surveyed rarely or never use PCAOB Form AP or are unfamiliar with it. 78% of audit committee members rarely or never use the PCAOB’s Registered Firms website or are unfamiliar with it.”

In this same comment letter, the commenter pointed to the results of their investor survey citing that “93% of investors surveyed trust the audit of financial statements, and a little over half trust it completely” and “92% of investors surveyed feel the information available to assess the quality of the audit of a publicly traded company meets all or most of their needs.”

Yet, our economic analysis points to two observations to address the “economic problem” that this standard is supposed to solve; specifically, that “[i]nvestors and audit committees cannot easily observe the services performed by auditors” and “[f]urthermore, there are currently insufficient incentives for firms to fully meet the market demand for accurate, standardized, and decision-relevant information.” Additionally, a commenter representing audit committees expressed concern that public access to the metrics could increase unnecessary risks, fearing public disclosure could result in litigation and reputational risks.¹⁰ The economic analysis acknowledges that the metrics could “encourage some frivolous lawsuits” but states that “it would largely contribute positively to audit quality”, even though the economic analysis lacks any supporting evidence or research to back its audit quality conclusion. In addition, the PCAOB dismisses commenter concerns by blithely ignoring, or at best, downplaying audit committee and investor commenters, who are among the intended users, of which more than a super-majority have stated that they have all or most of the information they need to assess audit quality.

Capacity and Cost Overburden Will Harm Audit Quality and Investors

As I have stated previously, continuing to force feed the auditing profession with a voluminous number of standards within the limited funnel of a couple years is going to have catastrophic impacts to audit quality. Capacity is an important factor that the PCAOB has not seriously considered as part of its most ambitious standard-setting and now midnight rulemaking agenda in PCAOB history. To put it into perspective, the amount of rainfall from Hurricane Helene in North Carlina alone caused biblical devastation due to the lack of capacity to absorb the deluge in such a short period of time. Are we intentionally creating a deluge to cause biblical devastation to the auditing profession and by extension to investors at large?

In terms of capacity, several commenters suggested the consideration of the cumulative effects of this standard, along with other rules and standards. However, our economic analysis rejects conducting an evaluation of the integrated impact, aggregated effects, and cumulative costs versus benefits of all the new standards, despite several commenters suggesting that the PCAOB do so. Specifically, the economic analysis states “[c]onsistent with long-standing practice and the PCAOB’s staff guidance on economic analysis, the Board’s economic analysis for each rulemaking considers the incremental benefit and costs for the specific rule – i.e., the benefits and costs stemming from that rule compared with the baseline.” The economic analysis states that there is limited academic evidence about whether the benefits exceed the costs because the necessary data does not exist. In other words, our economic analysis admits that limited evidence was gathered to support the adoption of this standard, qualitatively or quantitatively.

With respect to costs, the plethora of new standards, specifically the five adopted standards, seven short-term standard-setting projects, seven mid-term standard-setting projects, two research projects, and three rulemaking projects (one of which has been adopted)¹¹ will lead to exorbitant implementation costs. However, our economic analysis does little to effectively quantify the anticipated total costs of this standard, nor the cumulative impacts of all the newly adopted standards. Shockingly, the adopting release states “[w]e also believe that gathering data and calculating the final metrics, given the subjects they address, will not be overly costly, time-consuming, or burdensome”. However, the economic analysis in relation to direct and indirect costs associated with the final rules states that “[m]ost of the costs are intractable to quantify”, and admits that it is “[d]ifficult to estimate the potential costs that audit firms will incur to produce the final metrics owing in part to the variability in firms’ current systems.” However, the economic analysis attempts to extrapolate impacts from prior PCAOB disclosure rules, specifically the Critical Audit Matters (CAMs) standard and concludes that the“[p]opulation of firms expected to be impacted by the final requirements implies a total cost of approximately $67 million.” Note that this estimate does not include system implementation costs nor recurring system maintenance costs. For system implementation costs, the economic analysis references the implementation of Enterprise Resource Planning (ERP) systems and indicates that the costs could be up to $512 million if firms were to implement “from the ground up”. The CAMs standard has very different reporting requirements than this standard and it did not require a collection and validation of large amount of data from numerous systems, as such, I agree with the economic analysist that the costs to implement the Firm & Engagement Metrics standard could be much higher. Now, I do not expect penny perfection, but I do believe we should provide a better assessment of the economic impact of these reporting requirements, along the lines of whether this rule is likely to result in an annual effect on the economy of $100 million or more – which I have derived in part from the Congressional Review Act’s definition of ”major rule.”¹²

It is clear to me that our rushed standard setting agenda will increase audit fees exponentially, reduce capital formation, drive out audit competition, and intensify the talent shortage within this profession. So, I ask again, are we really protecting investors? Another commenter believes that only a small percentage of investors will benefit from this proposal and also acknowledged the indirect correlation of the metrics to audit quality.¹³ So why are we imposing costly requirements on an entire profession and indirectly public companies for negligeable investor benefits? Unfathomably, I do not clearly see where our economic analysis points to adequate supporting evidence indicating main street investors are asking for these metrics.

Disproportionate Burden to Small Firms Will Be Detrimental to Capital Markets Resiliency and the Economy  

As many are aware, I have repeatedly expressed concerns about the disproportionate burden we are placing on small firms. A community of small and medium firms submitted a comment letter for the first time ever.¹⁴ The commenter expressed serious concerns regarding the “pace and volume of the Board’s activities and its impact to smaller firms” as well as cites the importance of small companies on capital formation. Specifically, it states that “[a]ccording to the Fiscal Year 2023 Annual Report from the U.S. Securities and Exchange Commission (SEC) Office of the Advocate for Small Business Capital Formation, 99.9% of all businesses are small businesses, 43.5% of the U.S. GDP is created by small businesses, and 63% of net new jobs are created by small businesses”¹⁵ and “[s]maller accounting firms are deeply rooted in the local communities they serve.”

 

As I have stated on many occasions, small firms are important to our capital markets ecosystem. This adopting release will add tremendous strain on personnel and financial resources of small firms. On a broader level, the collective implementation of all the new PCAOB standards will detract focus from audit quality. Commenters shared my views on the negative impact on smaller firms. For example, a commenter expressed concerns regarding the disproportionate burden on smaller firms noting that the cost burden will likely accelerate the exit of smaller firms from conducting public company audits.¹⁶ My professional skepticism leads me to wonder if this adopting release is a thinly veiled tactic to create more avenues for inspection findings so that the PCAOB can rejoice in record-setting enforcement actions and civil money penalties.

Conclusion

For these reasons, I do not support this adopting release. I want to thank the staff for their hard work, particularly since they have been under intense pressure to rush to get this done. That should not have been the case.

I now have a few questions for the Chief Auditor and the Chief Economist.

Ms. Vanich:

1. Are you aware of any proposals adopted by PCAOB Board in less than 226 days?

   
   I have analyzed our rulemaking docket data. The only proposal with more than 40 comments adopted was AS2. It was adopted in 153 days and then it had to be amended three years later after a disastrous rollout and public outcry. 

2. Was any follow-up outreach conducted with the institutional investors surveyed? If not, why not?
3. Similarly, was any follow-up outreach conducted with the audit committee members surveyed? If not, why not?
4. In terms of costs, the adopting release states that producing the metrics will not be overly costly and burdensome. What is your definition of costly, given that the economic analysis estimates the “extrapolated” costs to be $67M, which is exclusive of system implementation costs that could be up to $512M? Would it be burdensome for your staff to report their hours on an individual standard project basis for cost accounting purposes?

Mr. Schmalz, the economic analysis lists the direct benefits as follows:

“The direct benefits of the final rules relate to (i) improved investor and audit committee monitoring, (ii) improved auditor selection, and (iii) improved PCAOB oversight and scholarly auditing research.”

It also references a study where “the benefits of comparable information have been observed in financial reporting.” However, many commenters expressed concern that the metrics would not be comparable or may be misunderstood.

5. What specific monitoring activities do you anticipate investors will perform over auditors?
6. As I have said many times, audit committees already have access to all the information needed to perform their oversight function over the external auditors. What evidence did you find where audit committees explicitly indicated that: (1) they are missing information necessary to perform their oversight duties; and (2) the specific reporting requirements here fill that gap?
7. What evidence did you contemplate in considering the comparability of metrics data across the varying size firms?
8. Do you believe in the value of post implementation reviews (PIRs)? Some commenters suggested that the PCAOB adopt a specific plan to conduct post implementation reviews, as referenced in the economic analysis.¹⁷ Unfortunately, the adopting release will not commit to a PIR and states “[u]nder the established PIR program, the Board expects that OERA staff will consider whether, based on these factors, a PIR might be warranted and, if so, OERA staff will recommend that the Board determine to conduct one. In other words, this deliberation should take place without any commitment.” In my opinion, this is a hypocritical position, where on the one hand, PCAOB invasively requires firms to publicly disclose volumes of firm and engagement information where the direct linkage to audit quality is questionable, while on the other hand, the PCAOB is unwilling to commit to conducting a review on the actual efficacy of this new standard. Will you commit to doing a post implementation review as suggested by the commenters? If not, why not?
9. I had previously referenced part of the Congressional Review Act’s definition of “major rule.” Can staff tell me if this rule is likely to result in an annual effect on the economy of $100 million or more?
   

Thank you. Back to you, Chair Williams.