What the PCAOB’s Pink Slip Could Mean for Public Companies
No matter how public companies react to the June 4 upheaval at the Public Company Accounting Oversight Board, there’s no question that companies’ audits and the oversight of auditors themselves will eventually look a bit different.
It’s likely that compliance will become more painstaking for issuers in that regard. Once the new PCAOB is appointed and settles in, we can certainly expect hard-nosed inspections of accounting firms’ audits. If life is about to get tougher for auditors, the auditors will in turn get tougher with public company accounting teams. The transition will take some time, but the result seems inevitable.
You’re fired...and you’re fired...and you’re fired...
On June 4, the Securities and Exchange Commission sacked not only Chair William D. Duhnke III, but also said it intended to seek replacements for all five board positions. The power move needed a majority vote from SEC Chair Gary Gensler and four other SEC commissioners (split 3-to-2 for Democrats), although the tally was not announced. Duhnke was a staffer for Sen. Richard Shelby, R-Ala., before the SEC appointed him chair of the PCAOB in 2017 (he was officially sworn in on January 2, 2018). Board member Duane DesParte, also appointed in 2017, will take over as chair temporarily, and there's no guarantee he’ll be around once the SEC names a new board.
Gensler did not hold back. "The PCAOB has an opportunity to live up to Congress’ vision in the Sarbanes-Oxley Act," he said. He vowed to set the agency "on a path to better protect investors."
Some turnover at the PCAOB was a given after President Biden’s election and his nomination of Gensler to lead the SEC, which appoints the PCAOB’s chair and its five board members, and approves its rules. Apart from Biden’s need for progressive support, former members of the board’s Investor Advisory Group and the watchdog group Project On Government Oversight (POGO) had slammed the PCAOB as an ineffectual regulator.
Only 10 days earlier, Sens. Elizabeth Warren, D-Mass., and Bernie Sanders, I-Vt., had written Gensler asking him to dump the entire board to “begin the serious work of rebuilding the PCAOB. This must start with a clean slate and a new direction in leadership.” Progress had ground to a halt due to board infighting, key staff departures, and Duhnke’s rule by fear, they argued.
The timing of the dismissals could not be coincidence, according to the two SEC Republican commissioners, Hester M. Peirce and Elad L. Roisman. “We have serious concerns about the hasty and truncated decision-making process underlying this action,” they said after the sacking. “The Commission has proceeded in an unprecedented manner that is unmoored from any practical standard.”
What needs fixing at the PCAOB
Unprecedented? Not exactly. Only four years ago, the SEC fired the entire board after a former PCAOB insider leaked confidential inspection plans to a Big 4 firm that another former PCAOB employee had joined. Duhnke took over after that purge.
Whether the PCAOB under Duhnke was bogged down in favoritism and ignored good advice from its advisory boards becomes a partisan argument. But there are areas that PCAOB critics point to as clear and objective evidence that the agency needs to change:
From 2003 to 2019, the PCAOB turned up 808 instances of Big 4 firms performing audits so defective, they should not have vouched for the client’s financials or internal controls—but those 808 instances resulted in just 18 enforcement actions (one in 50) against the firms or their employees, the watchdog POGO reported
In Duhnke’s first year at the PCAOB, enforcement actions plummeted by 63%
The PCAOB has recently struggled with key enforcement staff vacancies and cut its budget for accounting firm inspections, Sens. Warren and Sanders wrote in their letter
With greater attention and resources in these areas from the White House and SEC, auditing firms will certainly be dealing with a tougher PCAOB. And again, greater scrutiny of accounting firms always rolls downhill to increased demands on public companies by their auditors.
Other possible ripples
In my view, there are some other possible effects from the PCAOB remake:
As the SEC under Gensler demands more detailed environmental, social, and governance (ESG) disclosures, it’s logical to expect the PCAOB to prioritize ESG oversight too, particularly as the SEC seeks public input on rules that may require audit assurance over ESG disclosures.
More budget and manpower may result in more scrutiny of management review controls (MRCs), which have already been a painful source of audit deficiencies.
My colleague David Thande, Executive Advisor to the SOX & Internal Controls Professionals Group, expects the PCAOB will issue prescriptive guidance on the use of data analytics in the execution of financial audits. This will be a definitive move beyond the observations cited in the 2021 PCAOB Spotlight.
Watch for a clearer interlock of financial audits and cybersecurity risks, David says. The new board will definitely have a cybersecurity expert and chart the way for audit standards that incorporate cybersecurity risk.
The PCAOB could redouble its efforts to get access to conduct inspections and investigations in mainland China and Hong Kong, although that’s an uphill battle.
The sacking of the PCAOB’s leader likely marks a pivot point in the agency’s level of aggressiveness. And while pivot points come and go with presidential administrations, issuers should never shrug them off.
Critical Audit Matters Cheat Sheet
Learn how to navigate the recent changes to the audit reporting standard.