The Essential Role of Smaller Audit Firms to Investors and the Capital Markets

Remarks as prepared for delivery

Good morning and thank you Brian [Goodnough] for the kind introduction and starting us off this morning. Let me also welcome you to the PCAOB’s second 2024 Forum on Auditing in the Small Business Environment and on Auditing Broker-Dealers. It is wonderful to see approximately 100 representatives from over 40 firms. Auditors from smaller firms serve a crucial role in the financial reporting ecosystem and I look forward to the exchange of information and dialogue we will share today.

Throughout the day you will have the opportunity to talk with and hear directly from various PCAOB staff members, the technical experts, from our Division of Registration and Inspections (DRI), the Office of the Chief Auditor (OCA), and the Division of Enforcement and Investigations (DEI). In addition, we are fortunate to have staff from the Financial Industry Regulatory Authority (FINRA) with us. We will also have a pre-recorded message from staff of the U.S. Securities and Exchange Commission (SEC). All the presenters will provide updates and examples from their work in sessions throughout the day.

But, of most value today is the opportunity for us to engage directly with you. We have designed the day to be a discussion, not a lecture, on topics of importance to you. While we may not be able to respond to detailed questions involving specific facts and circumstances, our overarching goal is to be as helpful and responsive to your questions and comments as possible.

Before I continue, please know that my remarks reflect my individual views as a Board Member and do not necessarily reflect the views of the full Board, my fellow Board Members, or the PCAOB’s excellent staff. 

I am extremely excited we are meeting in person. As I mentioned, this is the second Forum of the year. After today’s event, my fellow Board Members will be hosting three additional in-person Forums this fall, in Denver, Miami, and the New York metro area. Some of you may recall from 2004 through 2019, the PCAOB hosted in-person Small Business and Broker-Dealer Forums at various locations around the country each year.

When I was in DRI, I had the opportunity to lead our inspection efforts for non-affiliated or smaller firms. During that time, I always looked forward to the chance to present at several Forums each year and having the opportunity to meet and hear from the individuals in attendance. I always benefited from hearing the questions, thoughts, and yes, concerns, about our inspection work, and I viewed the Forums as a key aspect of the PCAOB’s outreach efforts. The value of this interaction was significant; it allowed me to develop a deep appreciation of the complexities facing the auditors of smaller companies. These insights inform my view of the PCAOB’s activities in my current capacity as a Board Member. I believe it is essential to not only consider, but also understand, the unique and diverse nature of smaller firms as we contemplate new initiatives.

The presenters and I will be here all day, so please feel free to ask questions throughout the sessions and during the breaks. I will lead a brief wrap-up session at the end of the day for any remaining questions. Again, our goal is to make today a dialogue and I encourage you to take advantage of this opportunity.

During my remaining time this morning, I will provide opening remarks focusing on three areas. To start, I want to offer my perspective on the importance of the auditing profession to investors, the capital markets, and society as a whole, with a specific focus on the important role of smaller firms. I will then provide a brief overview of the PCAOB’s 2022-2026 Strategic Plan and how it will be touched on throughout the day, and share a few of my priorities as a Board Member. Then, we will move to a Fireside Chat discussion and leave time for your questions before the end of this opening session.

Smaller Firms’ Role in the Financial Reporting Ecosystem

As a certified public accountant and a former financial statement auditor, I constantly bear in mind the impact of our oversight on all firms – from the largest firms to the sole practitioner. To be clear, “the large accounting firms are not the only voice of this profession. America’s smaller firms and practitioners also make up a significant number of today’s practicing CPAs, and continue to do the profession proud.”¹

For the auditing profession to remain resilient, vibrant, and noble, smaller firms must continue to be healthy and able to perform high quality audits. Former SEC Chairman Arthur Levitt may have said it best: “[W]hether you are an accountant in a large firm, or a sole practitioner in a small town, every public accountant in America has been handed the same precious franchise, granted its special privileges, and charged with its care.”²

Small market capital companies, in many respects, are the engine of the U.S. economy. Smaller companies are often on the “ground floor” of new technologies and innovations; they are in vital industries like construction, healthcare, and financial services. In many instances, these companies are audited by smaller firms. A robust and active population of smaller firms is critical to serve these public companies and protect investors. In fact, small-cap companies report the highest proportion of shares held by retail investors, at an average of 23 percent. Forty-five percent of small-cap companies report an increase in retail holdings over the last 12 months.³ “The small practitioner helps to build businesses from the ground up. They establish the very bedrock on which today’s emerging companies will one-day grow to tomorrow’s global leaders.”⁴

Accordingly, it is clear that smaller audit firms have a significant role to play in support of investors and the capital markets. The PCAOB cannot be overly focused on larger firms. We are the oversight body for all registered firms; the Sarbanes-Oxley Act (“Act”) makes this clear. As of December 31, 2023, there were approximately 400 non-affiliated U.S.-based firms actively auditing issuers or broker-dealers.⁵

While the role that smaller firms serve is no less important than that of the larger firms, smaller firms have unique and different attributes; these must be recognized and acknowledged. Such differences and challenges may include: the use of and ability to invest in advanced technologies; access to talent due to a lower number of accounting graduates; greater use of outside specialists; audit partners and staff that may audit more private companies than public companies; consolidation of firms; and the growing trend of private equity investment in accounting firms and the resulting use of alternative practice structures. We recognize these challenges and the implications they have for your practices, and keep them top of mind as we consider initiatives and potential standards and rules.

The PCAOB’s audit oversight activities of smaller firms are a significant component of what we do. Over the past three years, our inspectors have inspected, on average, 142 annual and triennial non-affiliated U.S.-based firms. This average represents 88 firms that audit public companies and 54 firms that audit broker dealers. Collectively, these firm inspections included the review, on average, of 370 public company and broker-dealer audit engagements each year. As of the end of 2023, approximately 40 percent of public companies domiciled in the U.S. are audited by U.S.-based smaller firms.⁶ These audits represent market capitalization of almost $500 billion. Make no mistake, your work matters to the PCAOB, investors, and the capital markets.

Our inspections, in addition to being necessary to ensure the PCAOB is compliant with our inspection mandates as stated in the Act, help the Board and staff stay abreast of the issues and challenges facing smaller firms.

As you interact with us in the course of our inspection activities, I encourage you to talk with the PCAOB inspection teams assigned to you to ensure you understand their perspective on any noted deficiencies, engage early and in a comprehensive manner during the remediation process, consider providing comment letters to proposed standards and rules, and finally, ensure your partners and staff are aware of our Spotlight documents, including any related good practices noted. Please reach out to the staff when you have questions or concerns, or even to the Board if warranted. We value your views and perspectives. This year’s Forums are part of this process.

Preview of Today’s Topics

Now, I would like to shift and provide a summary of the PCAOB’s 2022-2026 Strategic Plan, and the areas that my colleagues will cover in more detail in later sessions. The Strategic Plan sets the direction of the PCAOB’s activities and has four primary areas of focus – three of which are outward facing and one with an internal focus.

• Modernize standards – This goal ensures our existing auditing standards are modernized, as needed, and are “fit for purpose” to meet the expectations of investors now and into the future. Part of this exercise is finding the right equilibrium regarding which firms are subject to the rules and standards, and what is required of them. For example, our recently proposed Firm and Engagement Metrics are currently proposed to be limited to audits of accelerated or large accelerated filers. For recently adopted AS 1000, General Responsibilities of the Auditor in Conducting an Audit, the release explains that the decision to shorten the timeline for document completion from 45 days to 14 days was made with potential challenges for smaller firms in mind. Some of our standards involve staggered start dates to allow smaller firms more time to update policies and procedures, as necessary.
  
  We have a number of recently adopted standards to review with you, and you will hear more about them later this morning from my colleagues in OCA. As we move closer to implementation of new rules and standards, we want to hear from you about what guidance would be most helpful.
• Enhance inspections – Our inspection reports have more transparency, including a new section on auditor independence and a range of other improvements to make the reports more transparent, relevant, and useful. In general, I believe the more transparency the PCAOB can provide around our audit oversight activities and the data we collect, the more useful it will be to investors, auditors, audit committees, the academic community, and other stakeholders. We have been making great strides to issue our inspection reports in a more timely manner. In fact, the majority of our 2023 inspection reports have been issued. My colleagues in DRI will share some additional information on these points and other recent developments.
• Strengthen enforcement – There has been a lot of coverage regarding our recent enforcement activities, which you will hear more about just before lunch. In our continuing pursuit of quality audits, enforcement plays an important deterrent role. I want to emphasize that, by law, all monetary penalties the PCAOB collects go directly toward scholarships to advance the auditing profession – they do not fund our operations in any way. Our 2024 scholarship recipients will be announced soon. Last year, nearly 70 percent of the recipients came from households with family incomes under $75,000.⁷ We continue to expand the number of academic institutions eligible to participate in the program to reach the largest possible pool of students. We recognize the talent shortage firms are facing, and, through the scholarship program, we hope to remove barriers for accounting students who otherwise might not have entered our profession.
• Improve organizational effectiveness – This last goal aims to ensure that we are executing our mandate as effectively as possible. This also includes our interactions with stakeholders, like this Forum today.

Together, these initiatives are designed to allow the PCAOB to meet the mission stated within the Act. Execution of these priorities will serve to not only benefit investors, but I feel strongly that they will also benefit the auditing profession.

Priorities Top of Mind

I will now turn to a few of my priorities, those larger themes that I try to keep in focus while performing my duties as a Board Member. First, the need for increased transparency. As I alluded to earlier, over the past year, the PCAOB has made substantial progress in increasing the amount of available information in our inspection reports, in part, with the inclusion of Part I.C. on independence matters.⁸ We have also increased the usability of our website with new search features for firms and inspection reports. This is an area that will continue to be a focus going forward.

Efforts at increased transparency also include a renewed focus on Critical Audit Matters (or CAMs). I am pleased CAMs is on our Standard-Setting Research Agenda.⁹ As you perform your audits, I encourage you to reconsider which matters meet the definition for reporting as CAMs. CAMs are an area of great interest to investors; it is important we all get this right. While still in the proposal stage, the potential Firm and Engagement Metrics, if adopted, would also increase transparency for investors and audit committees.

Another of my priorities is firm culture, which I continue to believe plays an outsized role in driving consistent high-quality audits. Firm culture includes the tone at the top, the middle, and at lower levels as well as the written and unwritten rules. DRI is in the midst of a firm culture initiative focused on larger firms.¹⁰ I am very interested in their findings, and what they may suggest for smaller firms. I also want to call your attention to SEC Chief Accountant Paul Munter’s recent statement, “Fostering a Healthy ‘Tone at the Top’ at Audit Firms,” focused on how messages from firm leadership can influence a firm’s ability to perform quality audits.¹¹ I encourage you to review his statement and reflect on the culture at your own firm.

The last priority I will touch on today is ensuring we hear from all stakeholders. We do so through measures such as the careful consideration of all comment letters and the activities of our Investor Advisory Group and our Standards and Emerging Issues Advisory Group, which I should note has two representatives from smaller firms, as well as hosting events like this. The PCAOB’s outreach and engagement with all stakeholders will ensure we have the best information to arrive at the “right answer.”

Conclusion

Let me conclude by first thanking Loyola Marymount University for providing this wonderful space for today’s Forum. Several Loyola Marymount accounting professors are with us today. I am grateful that they are participating in our conversations. Through your scholarly research and education of the next generation of accountants, the accounting academic community plays an indispensable role.

Second, thank you all for joining us and thank you for your role in supporting investors and the capital markets. Smaller firms, their partners, and staff are the backbone of the auditing profession. The work you perform is essential to a healthy and vibrant capital market. Teddy Roosevelt once said, “[F]ar and away the best prize that life offers is the chance to work hard at work worth doing.”¹² The work you and your firms do each and every day is work worth doing.

Thank you for your attention. We will now turn to the Fireside Chat and your questions.