Statement on the Firm Reporting Adopting Release – Extremism in the Name of Investor Protection

Remarks as prepared for delivery

Thank you, Chair Williams.

In the aftermath of one of the most consequential Presidential elections, I could not help but think about the words of another presidential candidate at his nominating convention more than 60 years ago “. . . extremism in the defense of liberty is no vice . . . . And . . . moderation in the pursuit of justice is no virtue.”¹ I oppose extremism – no matter the cause, because it is inconsistent with the theory of virtue elucidated by Aristotle, who believed that virtue is a mean between excess and deficiency.²  I believe that extremism errs on the side of excess whereas virtue calls for moderation.

The Firm Reporting adopting release makes it abundantly clear that the PCAOB believes that extremism in the name of investor and audit committee protection is a virtue and not a vice. The PCAOB believes that no reporting burden is too great for public company audit firms to bear even if: (1) the benefits are speculative; and (2) there are no direct linkages to improving audit quality. 

Specifically, the adopting release states that in general,

“we continue to believe that enhanced information regarding audit firms will support audit committees’ abilities to efficiently and effectively compare firms in their appointment decisions and monitoring efforts, and investors’ abilities to efficiently and effectively compare firms in their ratification decisions and monitoring efforts, and in their capital allocation decisions.  The required disclosures will also provide indirect benefits linked to audit quality . . . .”³

Against that back-drop, I want to narrowly focus on: (1) audit committees; (2) investors; (3) audit quality; and (4) the cumulative effect of the PCAOB’s reporting requirements.

I. Audit Committees

Now, the fact that the language I quoted from the adopting release first mentions audit committees, then investors, and then audit quality, is stunning to me.

First, it’s stunning because the PCAOB’s statutory mission under Title I of the Sarbanes-Oxley Act of 2002 (SOX) is to: (1) protect the interests of investors; and (2) further the public interest in the preparation of informative, accurate, and independent audit reports.⁴ The statutory mission statement does not mention audit committees, and the PCAOB has no statutory authority over audit committees.  Moreover, the mandatory reporting requirements the PCAOB is adopting today will not be included in audit reports. To quote a current SEC Commissioner, the PCAOB’s “role is important, but limited.”⁵  I am concerned that the PCAOB is compromising its mission when it attempts – through these mandatory firm reporting requirements – to expand its reach to other areas such as audit committees.

Second and perhaps most importantly, the reference to audit committees is stunning, because the adopting release does not discuss the two comment letters presenting the views of audit committee chairs and members. These comment letters make it clear that audit committees do not support the mandatory firm reporting requirements. The first commenter conducted a survey of audit committee members asking whether the proposed enhanced reporting requirements will be useful to audit committees in exercising their oversight role.  Of the 142 audit committee members responding, a near supermajority of 63% said “no.”⁶  The second comment letter stated “ACCs [audit committee chairs] do not think the proposed information . . . would enhance their oversight role: ‘I don’t find their proposals helpful at all to me, as an audit committee chair, in the effective execution of my responsibilities. . . .’”  This second commenter also noted that “[audit committee chairs] already receive or have access to most of the information that the proposals would mandate.”⁷ 

How can the PCAOB say in the adopting release that it “continues to believe” that today’s mandatory reporting requirements “will support audit committees . . .” when it fails to specifically mention, much less discuss, the audit committee comment letters. This failure indicates that this midnight rulemaking was rushed.

Now, the economic analysis does discuss the audit committee comment letters, but it does so in a result-oriented manner. For example, the economic analysis states that “37 percent of 142 [audit committee] respondents indicated that the reporting requirements will be useful to the audit committee in exercising its oversight role and 63 percent of the respondents indicated that the reporting requirements will not be useful.”  Those percentages are accurate, but the economic analysis blithely shrugs off the unequivocal views of a near super-majority of 63% of audit committee members who do not believe the mandatory reporting requirements will be useful. First, the economic analysis states that “commenters did not explicitly disaffirm the potential uses.”  If 63% of audit committee members surveyed state that the proposed reporting requirements will not be useful to them, that reads like an explicit repudiation.  Ask anyone if they consider a 37% approval rating to be an affirmation or a repudiation. Second, the economic analysis states that the PCAOB does “not rule out the possibility that investors or audit committees could have future needs for the required disclosures . . . .”  Third, the economic analysis states that “audit committees may come to appreciate the accessibility and comparability of the required disclosures . . . .”  These latter two statements are patronizing because the PCAOB is telling audit committees (and investors) that the PCAOB knows better than them about what they need.  It’s like me telling my child about her piano lessons, “you’ll thank me later.”  But the big difference here is: (1) the PCAOB is neither the parent nor the regulator of audit committees; (2) audit committees are not children; and (3) the PCAOB does not know better than audit committees about their current or future needs. I sometimes question whether the PCAOB understands its own current or future needs, so how can the PCAOB tell others what they need?

II. Investors

Turning to investors, one comment letter presented investor views in the form of a survey of 100 institutional investors. These institutional investors had assets under management (AUM) of $500 million or more, of which 41% had $5 billion or more in AUM.  For example, this survey asked whether certain types of specific information would be “extremely helpful.”⁸ The responses ranged from 35% stating that “network information” would be extremely helpful, to 37% stating that information on “fees” would be extremely helpful, to 50% stating that “information about a firm’s system of quality control/management” would be extremely helpful. However, the economic analysis acknowledges that the relationship of these percentages to the proposed reporting requirements is ambiguous, because the survey questions were not directly tied to the proposal’s mandatory reporting requirements.  Specifically, the economic analysis states that the 50% figure on the helpfulness of information about a firm’s system of quality control “did not ask specifically about Form QCPP.”    This ambiguity and the low percentages of institutional investors finding information to be “extremely helpful” should have prompted the PCAOB to conduct additional outreach to better understand what institutional investors need and will use, and whether the proposed reporting requirements are narrowly tailored to match up with those specific needs and uses. The PCAOB conducted outreach on its NOCLAR proposal, so doing so here would not have been unprecedented. But that would have taken time, and the PCAOB has decided to rush this midnight rule before it was ready so that it could have another notch in its belt, never mind the fact that the required disclosures will not directly improve audit quality.

III. Audit Quality

In my April 9, 2024, dissenting statement, I stated that “the proposal contains a significant expansion of reporting requirements, except that here there are no clear and direct linkages between the proposed new reporting requirements and audit quality.”⁹  I cited language from the proposal’s economic analysis stating “. . . the proposed disclosures would not have a direct relationship to audit quality . . . .”

Today’s economic analysis says much the same – noting that “[w]hile the required disclosures will not necessarily have a direct relationship to audit quality, they “may enhance audit quality” along with a mouthful of an explanation premised on audit committees and investors actually poring through the required disclosures. I believe that it is fanciful for the PCAOB to believe that audit committees and real investors will actually use the required information based on the surveys of audit committee members and institutional investors. As I noted earlier, 63% of audit committee members surveyed stated that they did not find the proposed reporting requirements useful, and it’s far from clear whether the institutional investors surveyed are likely to use the reported information. 

Now, the PCAOB has a mind-boggling response to two commenters “who suggested that without a direct link to audit quality, the benefits to investors and audit committees are uncertain.” The PCAOB states that “investor-related groups and audit committee members affirmed the usefulness of the required disclosures.”  First, the reference to “investor-related groups” pertains to investor-advocates and not real investors, like the institutional investors surveyed. Second, stating that audit committees affirmed the usefulness of the required disclosures is wholly unsupported and contradicted by the two comment letters presenting the views of audit committee members.

IV. Cumulative Effect of Reporting Requirements

In my April 9, 2024, dissenting statement on the proposal, I expressed concern about the Board imposing, in each new standard or rule, burdens on firms, without any quantification of the estimated burdens or costs. Illustratively, I also expressed concern about triplicative reporting requirements related to naming a firm’s principal executive officer; duplicative in the proposal’s amendments to Form 2 and triplicative where we saw the same reporting requirement in then proposed QC 1000.    

In that vein, several commenters suggested that the PCAOB consider the cumulative effects of the reporting requirements in the proposal along with other standards and rules that have recently been proposed or adopted. The economic analysis swats these comments away like a common house fly by stating that it considers the incremental benefits and costs for a “specific rule,” meaning it looks at cumulative costs and benefits only on a rule-by-rule basis. Sadly, these words ring hollow when we look at how the PCAOB responds to comments on triplicative reporting.

The adopting release states that it has eliminated the duplicative reporting requirement in Form 2 pertaining to identifying the principal executive officer – something that should have never been in the proposal in the first place. So no more triplicative reporting between Forms 2 and Form QC. But then the PCAOB justifies the duplicative reporting requirements in this adopting release and recently adopted QC 1000, by stating that such “duplication . . . was intentional . . . .  [W]e do not believe the reporting of a small number of names is overly burdensome, notwithstanding that firms have to report the names on Form QC (on a non-public basis) and on Form 2 (on a public basis).”  This statement is doubly disturbing.

First, by stating that the duplicative reporting requirement in this adopting release and in QC 1000 is “intentional” and not “overly burdensome” is inconsistent with what we say in the economic analysis as to how the PCAOB looks at cumulative costs and benefits. Second, it demonstrates not just indifference to commenter concerns about the cumulative effects of PCAOB reporting requirements but contempt, sheer contempt for commenter concerns.  The unbridled contempt conveyed in this adopting release and the corresponding abuse of power convince me that the PCAOB, like most financial regulators, should be subject to congressional oversight because unchecked regulatory power is dangerous and harmful to the capital markets. Such congressional oversight should perhaps include the Congressional Review Act, which is a tool that Congress may use to overturn rules issued by federal agencies.¹⁰  While the PCAOB is not a federal agency, I believe that it could serve as a helpful check on the PCAOB’s regulatory overreach.¹¹

For these reasons and the reasons stated in my April 9, 2024, statement, I cannot 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 some questions for the General Counsel and the Chief Economist.

Mr. Cappoli:

• You referenced the periodic reporting rule PCAOB adopted in 2008, do you recall how long that adopted rule took from proposal to adoption? [The rule adopted in 2008 took 749 days (25 months) and it only received 12 comments. The Firm Reporting proposal received 37 comments, three times more and yet only taking 226 days (7.5 months) to be adopted]
• Was any consideration given to conducting follow-up outreach with the institutional investors surveyed?
• Similarly, was any consideration given to conducting follow-up outreach with the audit committee members surveyed?
• The adopting release narrows the scope of firms subject to “material event” reporting to those subject to annual inspections, which is a positive change. Why are we not doing the same for “significant cybersecurity incident” reporting?
  

Mr. Schmalz:

• The economic analysis states that more recent research from this calendar year suggests that audit partner disclosures in Form AP provide useful information to equity markets.  My question is whether that is an overly broad statement since the study appears to narrowly relate to announcements of accounting restatements?
  

Back to you, Chair Williams.