The Public Responsibility of a CPA

Thank you for being here today and for your interest in the work of the Public Company Accounting Oversight Board.

By all accounts you have an outstanding program at the Spears School of Business (at Oklahoma State University) and I welcome the opportunity to tell you a bit about the PCAOB and provide a brief overview of what we do here.

You have a full program and you will be hearing from senior staff in our Division of Enforcement and Investigations, Office of the Chief Auditor, and Division of Registration and Inspections.

At the outset, I must tell you that the views I express today are my own and do not represent the views of the Board or staff of the PCAOB.

In today's session I will focus on four areas:

• Why the PCAOB was needed and created in the first place
• What we do here at the PCAOB
• A few of the Board's priorities
• A brief note about the future of the audit

To begin, I would like to congratulate you on your chosen profession.

Auditing and accounting are vital to the integrity of our capital markets, given that investors depend upon accurate, informative and independent financial statements to make informed investment decisions.

Your chosen career path will ensure the continuation of investor and capital market protection. As Lee J. Seidler, Deputy Chairman of the Cohen Commission, said at the hearings before the passage of the Sarbanes-Oxley Act,

"The last line of defense of fair financial reporting is a well-trained, informed auditor exercising independent judgment."^[1]

Without accountants and auditors, our capital markets — which are the envy of the world -- could not function as well as they do. The audit provides a safe foundation upon which investing decisions are made.

You have also chosen a profession where there will likely always be a demand for your expertise.

Public/Social Responsibility

I encourage you to never forget that the "P" in your future CPA stands for "Public," which to me means that you have a professional responsibility to serve the interests of the public as a Certified Public Accountant.

As you graduate and embark on your career, it is incumbent upon you to adhere to the highest ethical standards and to conduct yourself with total independence, objectivity and professional skepticism.

Nothing is more important than preserving your reputation. Given that auditing decisions are often made on the basis of judgment and the company pays for the audit, you will inevitably face a number of close-call decisions during the course of your career.

You will be pressured to do what it takes to retain a client, or to acquiesce to management. I would encourage you to always be objective and to remain true to yourself.

Background on the Creation of the PCAOB

The PCAOB was created to ensure that auditors of public companies and brokers and dealers are faithfully carrying out their duties on behalf of investors.

The covenant between auditors and the public was established in 1933 when Congress required public companies to file financial statements that would be reviewed by independent auditors.

This covenant places a special public obligation on auditors. In 1984, the Supreme Court, in United States v. Arthur Young, described the auditor's role as a "public watchdog function" that demands "total independence from the client at all times and requires complete fidelity to the public trust."^[2]

Unfortunately, in the late 1990s and early 2000s auditors lost sight of their responsibilities to the public, which led Congress to take action to police their work.

Accounting gimmickry at companies such as Enron, WorldCom, Tyco, Adelphia and Global Crossing included: cooked books, phony earnings statements, undisclosed transactions with corporate executives and other related parties, and inflated revenues, all of which went undetected by the auditors until it was too late, leading to massive restatements.

At the same time, there was an undeniable trend of the auditing profession moving away from strictly auditing to providing consulting and advisory services to clients.

Revenue from auditing services accounted for 70 percent of revenues in 1977 but only 34 percent in 1998.

Questions arose regarding the integrity of audits. It became more and more apparent that there were serious conflicts of interest between traditional auditing and the consulting and advisory services being provided to audit clients.

Auditors and consultants competed fiercely for business, which at times led to firms underpricing the audit in order to get the consulting work. In certain instances, auditors were encouraged to cross-sell their firm's advisory and consulting services to their audit clients.

This led to a major crisis of confidence in our markets. Investors lost approximately $67 billion from the collapse of Enron alone and more than $160 billion at WorldCom. Thousands of people lost their life savings and their jobs. And between April and July 2002, the stock market dropped more than 22 percent — or some 2,400 points.

In early 2002, Congress took action by holding hearings and crafting the legislation that would become the Sarbanes-Oxley Act.

One of the primary goals of the legislation was to replace the system of self-regulation in the accounting profession.

Under that system, auditors from one of the large accounting firms checked the work of auditors at another large firm. Interestingly, no audit failure was ever reported under that peer-review system.

As a result, the very first section of the Sarbanes-Oxley Act created the Public Company Accounting Oversight Board — an independent audit regulator.

Its mission is to "protect the interests of investors and further the public interest in the preparation of informative, accurate and independent audit reports."^[3]

Furthermore, the Sarbanes-Oxley Act enumerated a number of prohibited activities.^[4] These prohibitions were designed to prevent conflicts of interest.

For those of you who will become auditors, never forget that your primary client is the investing public — not management — and your primary purpose is to uphold investor protection and enhance audit quality — not to serve as a trusted advisor to management.

What the PCAOB does

So what do we do?

First, we register accounting firms. Any accounting firm that wants to audit public companies or broker-dealers must register with us. At the end of 2016, there were 2,013 firms registered with the PCAOB, including 1,113 domestic firms and 900 non-U.S. firms located in 89 countries.

Second, we inspect the audits of public companies and broker-dealers conducted by registered firms. The largest firms are inspected annually while the rest are generally inspected on a three-year cycle. In 2016, the PCAOB inspected 198 firms that audit public companies and examined portions of more than 780 audits. We also inspected 75 firms that audit broker-dealers and looked at portions of 115 of their audits.

Third, the PCAOB sets standards that relate to the profession — including auditing, quality control, ethics, independence and other standards.

Fourth, we enforce our rules and standards, as well as other laws, rules and standards that govern these audits. If registered audit firms or associated persons violate any of these, we have the authority to investigate and discipline the firms and individuals. In all our enforcement actions, the Board coordinates closely with the SEC Division of Enforcement.

In 2016, the Board made public a record 54 disciplinary orders with sanctions ranging from monetary penalties, to revoking a firm's registration, to barring an individual from associating with a registered firm.

The largest monetary penalty in PCAOB history was imposed in 2016 — an $8 million penalty against the Brazilian affiliate of Deloitte to settle charges that the firm issued materially false audit reports. Individuals within the firm attempted to cover up audit violations by improperly altering documents and providing false testimony.

I continue to be alarmed by the number of standards violations we see relating to the improper alteration of work papers and of our standards relating to independence and auditing of areas such as revenue recognition, allowance for loan losses, related party transactions, goodwill impairments, and internal control over financial reporting, as well as failures to cooperate with a Board inspection or investigation.

For a more complete description of the Board's activities, I would refer you to our 2016 Annual Report and our 2016-2020 Strategic Plan.

Priorities

Since coming to the Board, my primary focus has been to promote investor protection by improving audit quality and to ensure that the investor — not management — is recognized as the primary client of the auditor.

This is what the law intended. The very first words of the Sarbanes-Oxley Act are, "an Act to protect investors" and the Board's mission, as I mentioned earlier, is spelled out in the first section of the law: "… to protect the interest of investors and further the public interest in the preparation of informative, accurate and independent audit reports."^[5]

Transparency

One of our most significant accomplishments on behalf of investors became effective this year. Auditors must now name the engagement partner in charge of each and every audit of a public company.

Beginning January 31 of this year, accounting firms must file a Form AP for each audit report issued for a public company. On those forms, the firms have to identify the engagement partner and beginning June 30, information about other accounting firms that participated in the audit.

The filed forms are available on the PCAOB public website. You can search the data by engagement partner, audit firm or public company. So now investors, analysts, academics and students can find the name of the engagement partner of the audit of a specific public company and also learn the name, location or extent of participation of other audit firms that participated in the audit – information not previously available publicly.

This will provide investors with a means to determine whether certain engagement partners have been associated with adverse audit outcomes that could be attributed to deficiencies in their audit work or have been sanctioned by the PCAOB or the Securities and Exchange Commission.

I believe this requirement will reinforce the engagement partner's sense of professional responsibility and accountability for the quality of the audit through awareness that his or her name will be publicly associated with the audit that he or she supervised.

In turn, I would hope that firms and audit committees would value engagement partners who perform the highest quality work on behalf of investors.

Audit Reporting Model

Another important initiative of our Standards Division relates to modernizing the current auditor's reporting model. The current auditor's report in the United States has not been revised for decades and is essentially a pass-fail model. The Board has been working on a proposal since 2013 which would include a description of "critical audit matters," or CAMs, that would provide audit-specific information about especially challenging, subjective, or complex aspects of the audit. It is intended for these CAMs to communicate to the investing public issues that kept the auditor awake at night.

Compared to much of the rest of the world, the United States is behind in updating this report and I continue to hope that the Board will act on this proposal without much further delay.

Audit Quality Indicators

An additional important initiative relates to the Board's concept release dealing with audit quality indicators.^[6] I believe strongly that auditors should compete based upon audit quality, not price. Such competition would inevitably benefit investors.

Automobile companies compete by promoting such indicators as fuel economy and safety standards; the food industry competes based upon nutritional labeling; and other industries compete based upon other types of disclosures. I see no reason that audit firms should not also compete based on the public disclosure of audit quality indicators.

Disclosures such as staffing leverage, partner workload, industry expertise and PCAOB inspection results would benefit audit committees in making their audit selection.

Future of Audit

Technological Change

I would like to end by noting the tremendous pace of technological change that is taking place at many firms.

Almost every day we hear about a new product or technique that will revolutionize the way that auditors do their jobs. This evolution is necessary, but we must ensure that auditors utilize these tools to advance the causes of investor protection and improved audit quality.

These new technologies will require new auditors — you — to quickly gain skills in areas that aren't directly related to auditing and accounting.

I have heard from many students and professors that auditing and accounting students do not always receive the educational grounding in science, technology, engineering and mathematics that will enable them to thrive in this new environment. I would encourage you, to the extent possible, to seek out those classes to enhance your education.

I would also encourage you to remember that no technological advancement can take the place of a conscientious, knowledgeable auditor. Audit quality will suffer if the firms become too reliant on technology because even the most well-constructed tools can fail. I firmly believe that the tools the firms have developed, and will develop, should merely augment — and never be used as a substitute for — the essential work that auditors do on a daily basis. Nothing can replace the fundamentals and good judgment.

Conclusion

You are entering an exciting phase of your lives, and a profession that is essential to the functioning of the American and world capital markets. And you have a wonderful opportunity to serve the public by performing your duties with vigor and care. Your work will come with enormous responsibilities but also tremendous satisfaction in knowing that you are performing indispensable work for the public good.

Keep this in mind as you begin your careers. I wish you the very best.