Auditors Can More Easily Dispute PCAOB Findings

A new SEC rule outlines how accounting firms can challenge the defects their watchdog wants to share with the public.
Sarah JohnsonAugust 11, 2010

A little over a month since the Supreme Court blessed its existence, the Public Company Accounting Oversight Board will continue to face scrutiny, now from those it oversees as well as from its overseer.

A new rule from the Securities and Exchange Commission, which watches over the nongovernmental agency, makes it so. Going into effect September 7, the rule explains how accounting firms can dispute the PCAOB’s findings during its inspection process. The firms have always had this ability under the Sarbanes-Oxley Act, but the SEC lacked a formal appeals process. (Indeed, the June 28 Supreme Court decision, which affirmed the constitutionality of the PCAOB, arose out of a small accounting firm’s dissatisfaction with its 2004 inspection report.)

A key feature of the process is secrecy. If an accounting firm appeals to the SEC, the PCAOB will be prohibited from making disputed portions of its inspection report public until the commission completes its review, which could take anywhere from 30 days to more than 100 days. Moreover, the SEC could decide to keep the information private permanently if its reviewers determine that the PCAOB’s findings were “arbitrary and capricious.”

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Meanwhile, the public will learn nothing about the appeals process or the issues under contention, which will further cloud the results of PCAOB inspections for the accounting firms’ corporate clients that read them. “Until now, the SEC has not restricted the transparency of inspection reports pending the opportunity to seek review,” a PCAOB spokesman tells CFO.

However, requests for such a review could be minimal, says Matthew Rogers, director in the financial advisory services practice at AlixPartners, who has worked in the enforcement divisions of the PCAOB and the SEC. “The firms aren’t blindsided at any point in time about the inspection comments,” he says. According to former staffers, the PCAOB’s auditors talk to the firms about their findings and show them a draft of their reports before they are released to the public. (The agency inspects the nine largest accounting firms every year, and smaller ones every three years.)

Replacing the old system of self-regulation and peer-based review, the PCAOB’s inspections have added to “investors’ confidence in the financial statements that companies are releasing,” says Keith Peterka, a senior manager in the professional standards group at accounting firm Mayer Hoffman McCann who has worked in the PCAOB inspections group. But the inspections have not come without controversy. Critics have said the inspection reports generally highlight trivial issues and hide too many facts about the overall process and findings. The board keeps auditors’ client names confidential and redacts its conclusion about the firms’ quality-control systems, as long as the auditors make fixes within a year. Out of more than 1,150 inspections, the PCAOB has released data about auditors’ quality-control deficiencies only 74 times, all for small firms.

To be sure, Sarbox mandates that the board has to keep some matters confidential, resulting in published reports that some observers believe lack context and perspective. The result is a list of faults that the board’s inspectors have found with each firm, written in the most general of terms. While some of those deficiencies are major and lead to restatements, others are minor pings against the firms for, say, failing to show proof that a particular test was performed.

The larger accounting firms have generally shortened their response letters that accompany the reports, but some have used the opportunity to voice their discontent with the information that was made public. In 2007, for instance, Grant Thornton took issue with a PCAOB report that noted audit deficiencies at eight of the firm’s clients. “We strongly disagree with the use of overly broad comments such as ‘failed to identify,’” the firm wrote. “[The reports] do not adequately describe all of the relevant facts, nor do they acknowledge the extent of the procedures that were, in fact, performed by the engagement teams.”

But for the most part, accounting firms express their displeasure with their regulator behind the scenes. The new SEC rule could keep the public further in the dark, depending on how many times accounting firms turn to the commission for help. In return, however, the public could feel more assured that the PCAOB is subject to “increased accountability,” says Mark Taylor, an accounting professor at Case Western Reserve University’s Weatherhead School of Management.

The SEC believes the initial part of its review process — a 30-day period for deciding whether to take up the accounting firm’s case — will not “result in needless delays or routine appeals simply to delay publication,” according to the commission’s rule. Still, the new rule could further delay when the public learns about problems the PCAOB finds, a board spokesman acknowledges. There is already a long lag time for inspection reports to appear on the PCAOB’s Website. For instance, the board has yet to release its 2009 reports on KPMG and PricewaterhouseCoopers, and it has been more than a year since the 2008 inspection reports were published for those firms.

For its part, the PCAOB is trying to add more clarity to its processes, within the limitations imposed by Sarbox and the SEC. The board plans to ask Congress to allow it to publicize information about its disciplinary proceedings. Currently, several years can pass before the public learns that the board has a case against an accounting firm. That gives firms incentive to delay the proceedings, according to PCAOB acting chairman Daniel Goelzer. The PCAOB has issued 31 enforcement actions in the past seven years.

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