Stop, Look, and Listen: The Legacy of American Railroads and the Dawn of AI; A Transformative Tale of the Capital Markets, Accounting, Auditing, and Regulation

Good morning and thank you Iain [Robertson]. I sincerely appreciate the generous introduction and the opportunity to participate in the 2025 Association of American Railroads Accounting Officers and Internal Audit Division’s annual meeting. I always welcome the opportunity to talk about the important work of the PCAOB, and the essential service independent financial statement auditors provide to investors and our capital markets. These are two topics worthy of our constant attention and dialogue.  

Before I continue, please know that my remarks this morning are provided in my official capacity as an individual Board member and do not necessarily reflect the views of the full Board, my fellow Board Members, or the PCAOB’s dedicated and hardworking staff.

I was elated to receive the invitation to be with you this morning. Railroads hold a special place for me. Several of my relatives, including my father, spent their entire working lives employed by railroads. My father and I also shared a fascination with trains, including train travel, model trains, and collecting various railroad memorabilia. On each family vacation, I continue to keep an eye out for the nearest train station and railroad museum.

As I was gathering my thoughts for this morning, I reflected on how appropriate it is that we are meeting here in Chicago. Chicago is not only a great and important city in the U.S. and the world, but it was and still is an essential transportation hub for the movement of goods. Chicago has been called the greatest railroad center in the world.¹ The city “not only intercepts all the great trunk railroads, which reach with their connections from the Atlantic to the Pacific, but it forms a natural meeting and transfer point for those products of the West.”²

In the early 1900s, nearly half of the total railroad miles in the U.S. were directly connected to Chicago³ and today fifty percent of all intermodal trains pass through metropolitan Chicago.⁴ The city has been a special place, not only for railroads and transportation, but as the home to major financial exchanges such as the Chicago Stock Exchange and the Chicago Mercantile Exchange, as well as a number of accounting firms.

Nobility of the Financial Statement Auditor and Dedication to the Public Interest

As a former financial statement auditor and a longtime member of the accounting profession, it has been a captivating journey exploring the impact that railroads have had on what we know as modern accounting and auditing. Before highlighting the historical significance of the relationship with railroads, I want to discuss the societal role and value of this profession.

The independent financial statement auditor and accounting profession serve an unrivaled role in the financial reporting ecosystem and the capital markets. It is unrivaled because the auditor serves the public interest to benefit investors and society, rather than to represent a specific client or outcome. This has been part of the identity of the profession almost since its inception. In 1946, AICPA Executive Director and frequent commenter on the role and importance of accounting, John L. Carey remarked “[i]t is the peculiar obligation of the certified public accountant…to maintain a wholly objective and impartial attitude toward the affairs of the client whose financial statements he certifies.”⁵ Mr. Carey goes on to say that “[t]he certified public accountant acknowledges a moral responsibility…to be as mindful of the interests of strangers who may rely on his opinion as of the interests of the client who pays his fee.”⁶

Mr. Carey’s perspectives made nearly 80 years ago serve as an anchor and reminder for the auditors of today and tomorrow that what financial statement auditors do is more than just a job, it is a noble endeavor that, I believe, should be considered a calling. It is this service to the public that distinguishes a profession from a business or industry.⁷ As others have noted,⁸ I believe it is essential that we always refer to accounting as a profession as opposed to an industry. This is not mere semantics, rather it is emblematic of the technical expertise and reasoned judgement needed for financial statement auditors to fulfill their great responsibilities to investors and the public interest. 

But serving the public comes with a cost. The auditors’ duty to the public requires making hard choices and reaching conclusions that may put business relationships at risk in the short term.⁹ Yet, the auditors’ duty to protect the integrity of our capital markets for investors outweighs any given client relationship.

Making these difficult decisions develops the auditors’ credibility and trustworthiness, which is arguably their most precious commodity. It is investors’ trust in the integrity of the audit that provides them with the confidence to make investment decisions based on information gleaned from audited financial statements. Society at large benefits from the efficient allocation of capital and ultimately confidence in our capital markets more broadly.

Maintaining the auditor’s focus on investors and the public interest is key to upholding a profession that is resilient, vibrant, and noble. The work of the financial statement auditor is simply too important to investors and the capital markets; it is ultimately necessary to maintain our way of life.

With my remaining time this morning, I will focus first on railroads as the genesis of innovations in accounting, auditing, early audit committees, and federal regulatory oversight; second, provide an overview of the work and value of the PCAOB; and, finally, discuss current advancements in technology including artificial intelligence (or AI). More broadly, I suggest that innovations by American railroads played a pivotal role in making the U.S. capital markets the envy of the world.

Railroads as Innovators

There is a compelling historical connection between the development of American railroads and the evolution of the accounting profession. In fact, it might well be argued that each needed the other to achieve the indispensable place they hold in our world today. Just as America’s economic engine would quickly stall without freight railroads, so too would its capital markets without the assurance provided by independent financial statement auditors.¹⁰

The synergy of steam power, the telegraph, and railway development between the mid-19th and early 20th centuries reshaped commerce, leading to greater capital investment requirements and requiring improved information and capital flows.

While the telegraph ushered in an era of rapid communication and exchange of information, the railroads brought about the unprecedented ability to move large quantities of goods and people great distances at unheard of speed. Together, they represented the first modern businesses.¹¹ Railroads were also the first large-scale industry that was geographically dispersed with a great need for external capital. In fact, “[t]he railroads voracious demand for capital did more than anything else to create the modern New York Stock Exchange…Wall Street also became the center for the market for railroad debt.”¹² Of equal significance, “[t]he railroads spawned a new investor culture.”¹³   

The Genesis of the Modern Capital Markets

Starting around 1850, the railroads were the first private businesses to make large capital investments,¹⁴ which spurred innovations in business ownership, the construction trades, created investment banking, and helped turn the U.S. into a global economic powerhouse.¹⁵ Additionally, railroads were the first example of businesses operated by individuals that were not the owners.¹⁶

The railroads’ capital needs were unprecedented and, ultimately, they became the first private businesses in the U.S. to seek and acquire large sums of investment from all across the world.¹⁷ Enabling this level of capital formation necessitated an evolution in our capital markets. Trading in stocks ballooned from a few hundred shares in the 1830s to the trading of hundreds of thousands of shares weekly in the 1850s.¹⁸ Much of this activity was due to the trading and speculation on the New York Stock Exchange in railroad securities.¹⁹

The growth in scale of the railroads from a regional to a transcontinental endeavor with investors distributed around the globe also resulted in a revolution in accounting practices. According to Alfred Chandler, Jr., an economic historian and author of many books on the topic, the growth of American railroads during the 1850s and 1860s resulted in the creation of “nearly all of the basic techniques of modern accounting”²⁰ and, ultimately, “was central in the development of the accounting profession in the United States.”²¹

The Rise of Audit Committees and the Concept of Audit

As a precursor to today’s audits, railroads were the first businesses to recognize the need to validate financial information. “The American audit experience initially came about through the use of audit committees, especially shareholder audit committees. These audit committees served not only as ‘external’ auditors certifying the account balances, but they also served internal audit functions assessing internal control.”²²

The Baltimore and Ohio (or B&O) Railroad is credited with creating the first audit report.²³ In 1827, two years after the completion of the Erie Canal, merchants in Baltimore formed the B&O to compete with the flow of goods through New York State to the Great Lakes. The B&O’s charter required an annual “statement of affairs from management” while its by-laws required an “audit by the members of the board.” The board appointed two directors to examine management’s records and report findings to the members of the board. That report is the first known written corporate audit report. The report addressed the authorization of payment vouchers by the board, thus addressing the railroad’s internal controls for disbursements.

Similar reports from a subset of directors or a committee, a precursor to today’s audit committees, continued on a quarterly basis, much like today’s quarterly filings under Form 10-Q.

For the next several years, the B&O invested funds in rail design and construction. After concerns developed that recordkeeping of disbursements made by the superintendent of construction were “informal and defective,” this committee performed an operational audit, much like a modern-day internal audit, of policies and expenditures. This audit focused on operations and recommended streamlining certain “duties, responsibilities, and reporting authority.” As a result of this committee report, the board of directors made significant changes to the management structure, including adding segregation of duties.

These innovations were not limited to the B&O; they were adopted over time by other railroads, such as the Pennsylvania Railroad Company. Ultimately, the foundational structures and practices established by railroads influenced contemporary corporate governance, leading to the widespread adoption of audit committees as a standard feature of corporations.²⁴ 

In summary, “by the middle of the nineteenth century, auditors were involved in reporting to stockholders on the accuracy of management's financial data, in reporting on strengths and weaknesses in internal control, and in providing advice to management on needed improvements in controls and procedures.”²⁵ It was also “recognized that if the auditor is to be effective in these roles, then some degree of audit independence would be necessary.”²⁶

The Standardization of Accounting Practices²⁷

As railroad operations matured later in the nineteenth century, a need arose to formalize simple bookkeeping into consistent accounting practices. Accordingly, American railroads developed the basic techniques of today’s modern accounting, outpacing by decades parallel efforts in the manufacturing sector.

The new accounting practices developed by the railroads encompassed financial accounting, capital accounting, and cost accounting. I will spend a moment on each of these concepts.

First, railroads developed financial accounting, including the recording and compiling of financial transactions. These efforts evolved to include the accumulation of data and metrics for analysis, such as number of passengers and freight tonnage. These data and metrics were then used to develop operational ratios, such as earnings as compared to the volume of business and were the precursors to today’s earnings per share, price to earnings ratio, and profit margin metrics.

Second, railroads developed capital accounting to report on significant investments in capital, plant, and equipment. These developments ultimately led to practices to depreciate those investments and evaluate them for obsolescence, as well as to create reserve funds for renewals and repairs.

Lastly, railroads developed cost accounting. Albert Fink, a civil engineer and bridge builder at the B&O and later with the Louisville & Nashville Railroad, identified fixed and variable costs. Variable costs were further divided into components for the volume of freight and the number of trains operated. Fink emphasized that cost analysis should inform ratemaking, thus driving profitability of the railways.

The Penn Central Bankruptcy

Just as the railroads became the incubator for the growth of the accounting profession, they also led to opportunities for modern financial fraud, which served as the impetus for developing the regulatory framework that operates to this day. 

Railroads experienced a series of economic calamities starting in the 1870s that ushered in the Panic of 1873 and several other subsequent global economic downturns. Interestingly, some have analogized this time in our economic history to the more recent dot-com bubble.²⁸

Eventually, the growth in railroad companies gave us the bankruptcy of the Penn Central Transportation Company (or Penn Central). In 1970, the Penn Central bankruptcy was the biggest ever,²⁹ only to be eclipsed by Enron a few decades later.³⁰

Penn Central was born out of the merger of the Pennsylvania Railroad and the New York Central Railroad companies in 1968.³¹ Despite the many positive public statements and reassurances from management, the merger itself failed to produce a profitable company. Not long after the merger, the company was losing approximately $400,000 a day.³² These losses were masked, however, by accounting schemes that involved using non-railroad income to obscure losses from the core railroad business.³³

In the aftermath of the bankruptcy, policymakers in Congress and at the Securities and Exchange Commission (SEC) shined a light on the independent auditor’s failure to meet its duty to investors. An SEC staff report to Congress concluded that these schemes went undetected in part due to the failure of the independent auditor to look behind the form of the transactions. The SEC staff report stated that Penn Central stretched accounting principles “to cover novel situations, emphasizing form over substance on a number of major transactions” and thereby maximized reported income.³⁴

The SEC staff report went on to note that “[i]ndependent auditors bear a heavy burden of public responsibility” when reviewing these transactions and that being able to distinguish the reality behind a transaction is “essential if financial statements are to be meaningful to investors and creditors.”³⁵

The SEC subsequently reached a settlement with the auditor involving five different audits, where it chastised the auditor for failing to “exercise critical and independent judgment” in several instances.³⁶

In many ways, the failures of the independent auditors in the case of Penn Central foreshadowed what would happen 30 years later, albeit on a much larger scale, with Enron and WorldCom. The response of policymakers in Congress also foretold how important the role of the independent financial statement auditor had become to the functioning of our capital markets.

The Metcalf Report

Just as with Enron and WorldCom, Penn Central was only one of several audit failures during that timeframe.³⁷ In response, a Senate subcommittee spent two years on an in-depth study of accounting practices to determine whether new federal regulation of the accounting profession might be appropriate. A report titled “Improving the Accountability of Publicly Owned Corporations and Their Auditors”³⁸ was published in 1977. This report is more commonly known as the “Metcalf Report,” named for the lead author, Senator Lee Metcalf.

In many respects, the Metcalf Report foreshadowed the eventual driving force behind the creation of the PCAOB when it said that “[p]ublic confidence in the integrity and efficiency of the business community must be restored because such confidence is the key element in making the Nation’s economic system function effectively.”³⁹

Although the Metcalf Report identified several issues that impact audit quality, it did not call for action from Congress as it believed “the best and most effective way” to address the issues raised in the report was “through partnership between the private and public sectors.”⁴⁰ Ultimately, the subcommittee said that it was satisfied with “pledges from the accounting profession and the SEC that public concerns can be met without the need for new legislation.”⁴¹ From today’s vantage point, this conclusion was shortsighted.

The Metcalf Report, however, arguably planted the seeds for the creation of the PCAOB years later. First, the Metcalf Report called for the establishment of “an organization of accounting firms” to provide oversight to firms that perform independent financial statement audits of public companies. The Metcalf Report indicated that for this organization to be effective it needed to include all public accounting firms; have the authority to set standards; review the quality of public company audits and impose fines; and should be overseen by the SEC.⁴² If this sounds familiar, it is because it closely describes the powers Congress ultimately vested in the PCAOB. This idea was eventually proposed in the House of Representatives by Congressman John Moss in 1978,⁴³ but it would not come to fruition until decades later in response to the failures of Enron, WorldCom, and others.

Second, the Metcalf Report’s authors also raised an issue they said merited further study - the rise of the multinational corporation and its implications for accounting firms and U.S. capital markets. Namely, the authors acknowledged that the creation of the multinational corporation had led to a concurrent multinational expansion by accounting firms acting as independent auditors for those corporations.⁴⁴ As a result, the authors argued, that investors in U.S. markets had a direct interest in the quality of audit reporting performed around the world and, yet, the report laments that at the time there was “very little information available to Congress and the public on the organization and operation of multinational accounting firms and their foreign affiliates.”⁴⁵ To address similar concerns, Congress later empowered the PCAOB with the authority to regulate the work of registered accounting firms involved in the issuance of audit reports for public companies listed on U.S. exchanges regardless of the firm’s location.

The Interstate Commerce Commission

Before turning to the PCAOB, I want to highlight how the model that almost all federal regulatory commissions are based upon stems from the first efforts to regulate the railroads at the federal level. Congress passed the Interstate Commerce Act in 1887 in response to concerns from small businesses that railroad rates favored larger businesses.

This was the first federal five-member, independent “commission” created to regulate the activities of a specific industry. It served as a model for other regulatory commissions that would follow, including the PCAOB.

Overview of the PCAOB

As someone who has worked for the PCAOB for over 21 years, I have a deep respect and appreciation of how the authors of the Sarbanes-Oxley Act (“Act”) devised the PCAOB’s structure and operations. There are four elements, in particular, of the Act that I view as ingenious that achieve our mission to protect investors. It is worth noting that several of these areas were also mentioned in the Metcalf Report in 1977.

• Structuring the PCAOB as a non-profit corporation overseen by a five-member Board, of which only two members may be certified public accountants. This allows the PCAOB to maintain independence from the accounting profession and provides diverse perspectives to ensure the Board’s actions protect investors and promote audit quality.
• Housing the audit standard setting function and the inspection function in the same organization allows these groups to freely communicate on a real-time basis regarding current audit practices and quality matters and develop responses when actions are warranted. I personally have seen the undeniable benefits of these interactions over the years.
• Inspecting registered accounting firms located outside of the U.S. on a routine basis. This extraterritorial reach is unique to the PCAOB and allows for the regular inspections of non-U.S. firms, including those located in China and Hong Kong. 
• Using all civil monetary penalties collected from our enforcement cases to fund student scholarships. In 2024, the PCAOB provided $15,000 scholarships to 676 graduate and undergraduate accounting students.⁴⁶ To date, the PCAOB has provided over 2,900 scholarships totaling over $32 million.⁴⁷

It is important to first position the overview of the PCAOB’s activities by highlighting those four fundamental elements of the Act that, I believe, truly make the PCAOB such a unique protector of investors and drive our overall effectiveness. I also want to discuss the PCAOB’s formation and highlight our primary operations. 

After the downfall of Enron and WorldCom triggered an unprecedented economic fallout and a loss of trust in financial reporting, auditing, and the capital markets more broadly, Congress passed the Act in 2002 with near unanimous bipartisan support. The marquee feature of the Act was the creation of the PCAOB, an entity whose single purpose is the protection of investors through the oversight of the accounting firms that audit public company financial statements. It is not a stretch to say that every PCAOB staff member starts each day focused on protecting investors and improving audit quality. This single purpose is an important distinction that should not be overlooked or taken for granted.

I mentioned how the composition of the PCAOB’s five-member Board provides its independence. In addition, the PCAOB is substantially funded through annual fees paid by public companies as opposed to being supported directly by the profession or taxpayers. 

Congress, through the Act, tasked the PCAOB with four primary responsibilities.

First, registering accounting firms that prepare audit reports for public companies;

Second, adopting auditing, quality control, ethics, independence, and other standards for the audits of public companies to strengthen the reliability of financial statement audits for investors and other interested parties; 

Third, conducting inspections of registered accounting firms to assess the degree of compliance with the Act, the rules of the Board, the rules of the SEC, or professional standards and issue public reports on those inspections; and 

Fourth, enforcing compliance with the Act, the rules of the Board, professional standards, and the securities laws.

I will briefly discuss three of the PCAOB’s key duties: inspections, standard setting, and enforcement.

Inspections

Inspections are designed to assess a firm’s compliance with applicable laws, rules, and standards and include reviewing specific audit engagements and elements of the firm’s system of quality control.

Our 2024 inspections covered 171 firms and portions of 803 audits. Areas of common inspection findings include revenue, inventory, accounts impacted by business combinations, investment securities, allowance for credit losses, and long-lived assets, including goodwill and intangibles. Our inspection findings tend to be in the more complex and judgmental areas of the audit.

Prior to the establishment of the PCAOB, no other country had an audit oversight regime with this level of independence, authority, and reach. Arguably, in response to the types of concerns noted in the Metcalf Report, Congress made explicit that the PCAOB’s powers extend to the oversight of non-U.S. accounting firms that issue audit reports for public companies subject to U.S. securities laws or play a substantial role in the preparation and furnishing of such reports.

To facilitate inspections of non-U.S. firms, the PCAOB has entered into 28 bilateral agreements exclusive to the PCAOB and the home country regulator.⁴⁸ These bilateral agreements have, without question, enabled cooperation in the supervisory oversight of auditors and accounting firms subject to the two regulators’ jurisdictions. One such agreement you may be familiar with is with the Canadian Public Accountability Board (CPAB). We began performing joint inspections of Canadian firms in 2005 and work very closely with our CPAB colleagues. 

Each inspection concludes with the issuance of an inspection report, which may include deficiencies identified in the audits reviewed. If the firm determines it needs to perform additional audit procedures to support its audit report, it may need to contact and reengage with the public company to facilitate that additional audit work.

Standard Setting

Through the efforts of the Office of the Chief Auditor, the PCAOB sets auditing and attestation standards for public company and broker dealer auditors. In addition, the PCAOB sets broader standards and rules for quality control, ethics, and independence for the firms that perform the audits under our standards.

Our staff is focused on modernizing the auditing standards the PCAOB adopted on an interim basis in April 2003. The current standard setting agenda⁴⁹ includes audit performance standards, in part, on substantive analytical review procedures and auditing inventory. We also have research projects on Critical Audit Matters (or CAMs) and on the use of data and technology in audits.

When new standards are proposed, we seek feedback from all stakeholders, including from the preparer community and audit committee members. I encourage all interested parties, and certainly the preparer community, to subscribe to the updates on our website to be notified of opportunities to comment on standard setting proposals.

I want to briefly mention QC 1000, A Firm’s System of Quality Control.⁵⁰ QC 1000 becomes effective on December 15, 2025 and establishes a risk-based framework for a firm’s quality control system to proactively manage the quality of audit engagements. In a general way, QC 1000 is analogous to internal control over financial reporting for public companies. I encourage you to talk to your auditors about their QC 1000 implementation status. Our staff has issued implementation guidance, is holding in person training workshops, and published videos to assist firms of all sizes in their implementation.

Enforcement

The PCAOB is charged with enforcing professional standards and other related laws and rules governing the audits of public companies and broker-dealers. Our Division of Enforcement and Investigation evaluates potential violations by registered accounting firms and associated persons of these standards, laws, and rules.

When violations are found, the PCAOB may impose sanctions, including censures, monetary penalties, and limitations on a firm’s or an individual’s ability to audit public companies or broker dealers.

Outreach

Finally, the PCAOB staff periodically issue Spotlight documents.⁵¹ These documents are designed to help auditors, audit committees, investors, and preparers understand the PCAOB's activities and observations. Examples of Staff Spotlights include information on the PCAOB’s annual inspection plan, an overview of inspection results, auditing accounting estimates, considerations on using the work of specialists, and observations related to auditor independence. In addition, in December 2024, our staff issued a Spotlight: Insights on Culture and Audit Quality.⁵² I continue to believe that an accounting firm’s culture has an oversized impact on its ability to consistently perform high quality audits. Our Spotlight documents are valuable to preparers by providing context and insights into areas of PCAOB focus and can also help to inform discussions with your auditors. I encourage you to stay abreast of our Spotlight documents.

Potential Impact of Today’s Technology Advancements

As I previously mentioned, railroads facilitated one of the most pivotal technological advancements of its day – the deployment of the telegraph which enabled faster communication across the continent.

The telegraph and railroad industries had a symbiotic relationship. Railroads used the telegraph to coordinate train operations, and the telegraph industry used the railroad right of way to extend their reach across the country.⁵³ In fact, the telegraph supercharged communications at the time, which impacted nearly every other industry, including the accounting profession. But it also introduced new risks. For example, the telegraph enabled more people to invest in our public markets. So much so, that the volume of trading on October 28, 1929 overwhelmed the New York Stock Exchange’s ability to process those trades, contributing to panic selling on Black Monday.⁵⁴   

Today, we are faced with another revolutionary technology - the emergence of advanced technologies including generative AI. It was recently said that the “[b]usiness deployment of artificial intelligence has reached a tipping point.”⁵⁵ As we know, this technology is evolving rapidly. Not a week goes by without an announcement of a new AI development and the pace of change will likely only continue to increase. Many observers have speculated that this will have massive implications for every white-collar job in existence, including the accounting profession.

Accounting firms see promise in AI. The largest accounting firms are investing billions of dollars in AI applications. These investments are focused on areas such as using AI to detect accounting fraud and AI agents to perform audit tasks. In a July 2024 Spotlight on generative AI use in audits and financial reporting,⁵⁶ our staff identified areas of current AI use in auditing and in the financial reporting process. While these areas tended to be in accounting and auditing research, preparation of memoranda and other more administrative areas, audit firms and preparers alike emphasized that they are continuing to explore various ways of integrating generative AI-enabled tools in auditing and financial reporting.

While this promise of AI is being explored, the potential risks are also becoming increasingly evident. AI can hallucinate results, ranging from misleading to fabricated.⁵⁷ Researchers have found that AI can also reflect biases that exist today.⁵⁸ Perhaps even more worrisome, researchers have found that AI can strategically lie to avoid being modified.⁵⁹ There is also the more general risk of automation bias whereby humans favor suggestions from automated systems over human judgement and ignore contradictory information.⁶⁰

Challenges for the Auditor

Accounting firms will have to consider these broad challenges as they look to use technologies to change and alter the work of auditors. In particular, AI will certainly further automate and change both the finance and audit functions.⁶¹