Statement on the Firm Reporting Proposal – Are We Regulating the Audit Firms or Driving Out Competition?

Remarks as prepared for delivery

Thank you, Chair Williams.

The proposal states that the proposed additional reporting requirements are necessary or appropriate in the public interest or for the protection of investors, and, if adopted would enhance firm transparency and improve the PCAOB’s oversight of firms. Similar to the Firm and Engagement Metrics proposal, this 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.¹ This proposal focuses on reporting related to registered firms’ operations, structures, and financial performance. In some cases, it is not clear to me what PCAOB could or would do with the information we are asking for other than sharing it with the SEC. For example, the proposal would require the largest firms to provide annual financial statements to the PCAOB. The proposal states that obtaining such information could “facilitate the Board’s regulatory response in the event of, for example, special reporting of solvency-related events . . . if the PCAOB has more complete current financial information already on hand . . . . While financial distress does not always predict the collapse of a firm, we believe it can be helpful in indicating vulnerabilities and in understanding the significance of risks posed by certain solvency-related events.” While the annual submission of financial statements will surely be informative, mandating information that we have no authority or ability to do anything about² could be reasonably construed as a gross overreach and an abuse of regulatory power. The proposal makes no attempt to be transparent about the PCAOB process and criteria for evaluating the firms’ level of financial distress. Monitoring financial stability of a specific marketplace that could impact broader U.S. financial stability is the role of the Financial Stability Oversight Council (FSOC)³ in which the PCAOB is not a member. ⁴

In addition, this proposal contains reporting requirements that appear to overlap with or are duplicative of reporting requirements contained in a different proposal, specifically QC1000.⁵ Under the QC1000 proposal, firms would be required to report the firms’ governance structure related to their system of quality control annually and confidentially; specifically, by identifying the individuals assigned (1) ultimate responsibility for the firm’s QC system as a whole; and (2) operational responsibility for the QC system as a whole. This proposal would duplicate the same reporting requirements in proposed Form 2, Item 1.4.a and 1.4.c which would require firms to annually identify the principal executive officer of the firm and the executive officer(s) that oversee the firm’s audit practice. Unlike proposed QC 1000, this proposal would make this same information public. To make matters worse, Form 2, Item 1.4.a and Item 1.4.e contain duplicative reporting requirements.  Specifically, Item 1.4.a would require each firm to identify its principal executive officer.  Item 1.4.e would require each firm to identify the individuals who have responsibilities under paragraphs .11 and .12 of proposed QC 1000.  Paragraph .11 specifies that the firm’s principal executive officer is ultimately responsible and accountable for the QC system as a whole.  As a result, Item 1.4 would needlessly require each firm to identify the same information twice; and if proposed QC 1000 is adopted, this proposal and QC 1000 would require triplicate annual reporting of this same information – twice publicly and once confidentially.  I am troubled by the incoherent transparency position we are taking on the same information. This incoherency is also evident in this proposal’s annual and public reporting requirement in Form 2, Item 1.4.f, that each registered firm provide a description of the firm’s independent oversight function – the substance of which mirrors paragraph .28 in proposed QC 1000.  I am thus deeply troubled by our blatant disregard of the duplicative (if not triplicative) and excessive reporting burdens we seek to impose as this proposal quantifies neither the increased reporting requirements nor the estimated reporting and recordkeeping costs. Emphasis added.

By my staff’s count, the proposal contains approximately 38 new reporting requirements or elements that are either one-time, annual, or episodic. The proposal appears to be erroneously premised on the assumption that “more disclosure” by every single registered firm regardless of size or circumstance equates to “better disclosures” for investors and for our oversight function. Emphasis added. As of December 31, 2023, 49% of registered firms covered by this proposal are not providing services subject to PCAOB oversight (including PCAOB inspections), because these firms have not issued an audit report or played a substantial role in an audit, for a public company, broker, or dealer, over the past three years.⁶ These firms are “inactive” firms, and I am unclear on the value for investors of more burdensome reporting from these firms when they have never or may never conduct audits subject to PCAOB oversight.

Some might argue that if these inactive firms do not wish to be subject to the proposed reporting requirements, then they can withdraw their registration status. Inducing inactive firms, either purposely or inadvertently, to withdraw their registration status has the potential to reduce competition in the audit marketplace, since it will be more difficult for inactive firms to become active and enter the public company audit marketplace if they need to re-apply for registration. 

Furthermore, the proposal would require every previously registered firm to file Form QCPP upon the PCAOB’s proposed QC 1000: (1) being adopted by the PCAOB Board; (2) being approved by the SEC; and (3) the Form QCPP reporting requirements becoming effective. 

Every registered firm would then be required to provide a description of the firm’s quality control policies and procedures, which must comport with the requirements of QC 1000.⁷ Completing Form QCPP is no small task. Even if each of the 11 descriptions is “brief,” the overall description is likely to be many pages in length. The proposal indicates that the policy rationale for Form QCPP reporting is that it would “increase transparency to investors and audit committees, who could then evaluate whether and how firms are addressing QC 1000.” 

This is a baffling justification for inactive firms who are not looking to be selected for an “engagement” by any audit committee.  It is thus an unreasonable policy to require the 49% of all registered firms that are inactive to report on their policies and procedures that conform with QC 1000 via Form QCPP. 

This proposal makes me wish the PCAOB were a federal agency where this proposal’s reporting and recordkeeping requirements would be subject to review by the Office of Management and Budget’s Office of Information and Regulatory Affairs under the Paperwork Reduction Act of 1950, as amended (PRA).  But, I know that SOX expressly states that the PCAOB is not an “an agency or establishment of the United States Government,”⁸ which means that the PCAOB is not subject to the PRA.  The PRA is designed to reduce the paperwork burden the federal government imposes on private businesses and citizens, so as to “not overwhelm them with unnecessary or duplicative requests for information” and “to make sure the data [federal agencies] collect is accurate, helpful, and a good fit for its proposed use.” ⁹ The PRA is also designed to help prevent federal agencies from imposing “excessive burden” on private businesses and the public, which include burdening more respondents than necessary.¹⁰ I believe that asking inactive firms to submit Form QCPP is “excessive,” “unnecessary” and not “a good fit for its proposed use.”  Emphasis added.

Furthermore, as I noted earlier, this proposal quantifies neither the increased reporting and recordkeeping requirements nor their estimated costs. This would not be the case if the PCAOB were subject to the PRA, because the PRA requires federal agencies to estimate the “burden” on the public in complying with recordkeeping and/or reporting requirements, where the estimate of the “burden” “includes the value of both the time and the effort to fulfill a collection along with the financial cost.”¹¹

My point is that the PCAOB admirably gives stakeholders notice and an opportunity to comment on this proposal as if we were a federal agency subject to the Administrative Procedure Act, but then less admirably elects not to follow the PRA.¹²

I am profoundly worried that the Board’s apparent zeal to impose, in each new proposed standard or rule, new burdens on firms, without sufficient tailoring and without quantifying the estimated burdens, may end up breaking the public company auditing profession’s back, particularly for small firms. If we “break” the profession in the name of investor protection, are we really protecting investors? 

I also want to mention that I have been reading comment letters on our various proposals as well as meeting issuers, audit committee members, and other stakeholders to better understand what disclosures actual investors want. One comment letter on a different proposal stood out. This commenter wrote “more disclosure does not necessarily mean better disclosure, especially when the additional disclosure is difficult and expensive to prepare and does not meaningfully improve an investor’s ability to assess a company’s business and operations.” ¹³ I am concerned that we may be overstating in this proposal how “more” is “better” for investors. For example, the proposal states that “aspects of firm structure, resources, and operations” would, for example, “improve investor confidence in public company audits because it would increase the information available to efficiently and effectively evaluate a firm for ratification.”

I found this statement stunning, because it seems we are trying to fool investors into believing that their votes on auditor ratification are binding when we later state the exact opposite in a footnote in the proposal’s economic analysis. This footnote states that shareholders “[v]oting on a proposal to ratify the appointment of the audit firm is not statutorily required and in many cases the ratification vote is non-binding.” By overstating the benefits of increased reporting for investors, we lose credibility and may cause others to reasonably question the effectiveness of the PCAOB.

Earlier, we voted on the Firm and Engagement Metrics proposal. I have already expressed my concerns about some of the burdensome reporting requirements in my earlier statement. This proposal would add yet another set of overly broad and unduly burdensome reporting requirements. Additionally, the QC 1000 proposal which was voted on by the Board 18 months ago would require an extraordinary amount of recordkeeping by registered firms. Since then, we have issued five additional proposals not including the two today. While it is important for us to work as fast as we can, it is imperative that we do so responsibly and not act in haste. Standard-setting and rulemaking require a careful and thoughtful deliberative process because our capital markets can be fragile and rushing burdensome, complex, and consequential rules and standards without quantifying the burdens on affected stakeholders could damage the long-term stability of our capital markets. It is therefore crucial to consider the interconnectedness of these proposed standards and rules as well as the cumulative impact of their burdens on stakeholders, especially with regard to QC 1000, Firm and Engagement Metrics, and Firm Reporting. 

Because I believe this proposal represents an overreach of regulatory power and stands to undermine competition in the audit marketplace as well as investor protection, I dissent.

I would like to thank the staff in the Office of the Chair, the Office of the General Counsel, and the Office of Economic and Risk Analysis, for their hard work in getting this proposal completed in the midst of many other priorities.

I now have a few questions for the staff.

1. Staff commendably developed and applied a three-part test to narrowly tailor the financial statement reporting requirement to only the largest firms.  Was this three-part test or some variation used elsewhere to narrowly tailor firm reporting requirements? 
   
2. What impact do you think these requirements will have on the concentration of the audit marketplace? To what extent have the proposed reporting requirements been informed by the economic analysis especially concerning the unintended consequences acknowledged in the economic analysis to the small and medium size firms?
   
3. As a follow up to your answer, in the economic analysis under unintended consequences, you acknowledge that the proposal could cause firms to exit the public company audit market and reduce competition.  But then you write that this potential unintended consequence would be mitigated to the extent that the remaining firms expand their market share by perhaps acquiring additional capacity from the exiting firms. Can you explain how a smaller number of firms with a greater market share mitigates a reduction in competition?
   
4. The economic analysis states that staff considered quantifying the compliance burdens under the PRA, and that it specifically considered surveying firms.  Did staff conduct any such survey to quantify the burden?