Investors are worried about the Public Company Accounting Oversight Board (the “PCAOB” or “Board”). Over the past few years, the Board, which was created to oversee the audits of public companies, has experienced significant turnover, terminations in key positions, decreased transparency in rulemaking, an overreliance on out-of-date industry standards, and a steady decline in enforcement actions. Now, with Gary Gensler taking the reins at the Securities and Exchange Commission (“SEC”), investor advocates hope change is coming.
The PCAOB was created by Congress in 2002 with the enactment of the Sarbanes-Oxley Act (“SOX”) “to oversee the audit of public companies that are subject to the securities laws, and related matters, in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports for companies the securities of which are sold to, and held by and for, public investors.” SOX further authorized the PCAOB to establish investor advisory groups to better fulfill its mission through investor input. The SEC has oversight over the PCAOB, including approval of the Board’s rules, standards, and budget.
Since 2002, the Board has suffered ups and downs, including its share of scandals. But today, critics worry that it has become a toothless regulator, with the SEC taking active steps to curb the effectiveness of the PCAOB and its mission. In 2017, the SEC replaced the entire board and terminated the general counsel, chief auditor, director of information technology, and other high-ranking staff. In 2018, the PCAOB moved to reduce its own budget as part of a strategic plan that only mentioned “investor protection” once. That same year, the Board halted all advisory group meetings, shutting the door on investor feedback. Further, the Board has curtailed public comments in rulemaking, and it relies on auditing standards written by the American Institute of Certified Public Accountants (AICPA) that are over twenty years old. Critics note, “[T]hese standards were written in an era of flawed self-regulation that failed to prioritize the interests of investors and the public. In fact, these standards also contributed to the failed audits of companies such as Enron.” Equally troubling, the PCAOB has failed to conduct regular meetings, post agendas for the few meetings it does hold, and adopt whistleblower protections.
The Board’s inertia is most evident in the paucity of enforcement actions. Throughout 2020—despite the pandemic—the SEC remained on track in terms of its expected number of enforcement actions relating to accounting and auditing. While there was a slight dip in enforcement actions during the first quarter of 2020, the SEC’s enforcement activity quickly returned to pre-pandemic levels. By contrast, the level of PCAOB enforcement actions has been in a tailspin. According to a recent Cornerstone Research report, the PCAOB publicly disclosed only 13 enforcement actions involving auditors in 2020, which amounted to just half of the 24 actions it brought in 2019. Moreover, the PCAOB’s enforcement actions saw a 39% drop as compared to the 2015-2019 period.
The PCAOB has pushed back against criticism, arguing that the lack of enforcement activity is a sign of success. Spokesperson Jackie Contrell commented, “The Board’s strategic approach is to prevent audit violations from occurring in the first place, which if we do it effectively, will naturally lead to fewer enforcement cases. That’s a good thing for audit quality and investors.”
Not everyone is buying the PCAOB’s “less is more” explanation. And now, with a new administration in Washington, and a new SEC chair, several former PCAOB Investor Advisory Group (“IAG”) members are pushing for change.
On April 19, 2021, a dozen former members of the PCAOB’s IAG wrote an open letter to SEC Chair Gensler highlighting the “urgent need to reinstate” the IAG and “restore investor trust and confidence in the quality of public company audits in the United States.”
The letter, which included signatories from CalPERS, COPERA, and former Chief Accountant of the SEC Lynn E. Turner, outlines a series of troubling actions at the PCAOB and highlights several areas of concern, including the elimination of public comment from rulemaking, reliance on flawed and outdated auditing standards, and the failure to hold regular meetings, among others. “We share these concerns about the overall direction of the PCAOB, including a significantly diminished emphasis on maintaining sufficient investor protections in the oversight of the financial reporting process. This concern is further intensified by the appointment of PCAOB board members who lack independence and the PCAOB’s recent move to reduce auditor independence rules without any investor input whatsoever.” The letter continued, “[G]iven the significant personnel changes, budget reductions and anti-regulatory activity at the PCAOB, there is considerable heavy lifting ahead to return the PCAOB’s focus to its primary mission of investor protection. Given their track record, we do not believe the current PCAOB Board members are up to the task of re-focusing the PCAOB on its core mission because they are responsible for the dramatic shift away from what investors expect.”
As of this writing, neither Gensler nor the SEC has publicly responded to or commented on the letter.
The PCAOB was created in the aftermath of widespread accounting and auditing failures. It serves as a watchdog over the watchdogs. Independent auditors are key gatekeepers, reviewing a company’s financial statements. Robust, independent auditors are vital to ensuring confidence in a company’s reported financial filings. Likewise, rigorous oversight of those auditors is crucial to protect investors and our public markets. It is time for investor voices to be heard again at the PCAOB. One can only hope that SEC Chair Gensler agrees, as no one wants to return to the days of Enron and Arthur Andersen.