Jay Hanson, one of the newest members of the Public Company Accounting Oversight Board, gave a keynote address at the Compliance Week 2011 conference in Washington D.C last month, followed by a question and answer period. With so much material to cover, Hanson didn't get to many of the insightful questions members of the audience submitted. Hanson graciously agreed to answer them after the event.
Hanson and the rest of the PCAOB board are taking up an aggressive agenda, assessing the state of the audit profession and looking for ways increase audit quality, including possible changes to the audit report.
What is the Board's assessment of the risk that as auditors discuss more about financial statements and judgments, companies will become more or overly conservative in the financial statement preparation?
The PCAOB has engaged in extensive outreach to understand if and how changes to the auditor's report could benefit investors. Our outreach underscored that investors clearly want more from the audit report, including information from the auditor regarding the auditor's views on audit risk, management's judgments and estimates, and the quality of management's accounting. Others have raised concerns about whether auditors should provide any information about the company that has not come from management. The Board anticipates releasing a concept release on this issue for public comment this summer, and hosting a roundtable in the fall to seek additional input. The Board will consider carefully all comments received about possible risks, costs, and unintended consequences arising out of changes to the report—including any potential effects on management's actions or disclosures—before issuing a proposed standard.
If you're going to have stronger enforcement of audit firms that means a more detailed look at audits and audit work, no? Will companies be informed if you find something amiss?
One of the Board's primary activities is to conduct inspections of audit firms to assess the degree of compliance of each firm with applicable laws, rules, and standards in connection with the firm's performance of audits. Occasionally, information comes to the Board's attention through inspections (or through other means) that merits the initiation of an investigation by the Board's Division of Enforcement and Investigations in order to determine whether and to what extent an audit firm or audit personnel failed to comply with the Board's audit standards and other applicable laws. In conducting its investigation, the Board's Division of Enforcement and Investigations carefully reviews work papers and other documents and takes the testimony of audit personnel. If, at the end of an investigation, the staff believes that disciplinary proceedings are merited, it will make a recommendation to the Board to initiate proceedings against the audit firm and/or audit personnel.
Jay Hanson was appointed by the Securities and Exchange Commission to be a member of the Public Company Accounting Oversight Board in January 2011.
Prior to joining the Board, Hanson spent nearly 32 years at McGladrey & Pullen, where he worked with a variety of clients ranging from small non-profit organizations to large multi-national public companies. At the time of his departure, Hanson was the national director of accounting, overseeing the firm's accounting guidance and training practices, as well as leader of the firm's Accounting Standards Group.
Hanson served as a member of the Emerging Issues Task Force of the Financial Accounting Standards Board from 2006 to 2011. He also was a member of the Financial Reporting Executive Committee of the American Institute of Certified Public Accountants from 2005 to 2011, serving as chairman from 2008-2011.
Board investigations are confidential under the Act, and the Division of Enforcement and Investigations is not permitted to disclose an investigation solely for the purpose of informing the company whose audit is being reviewed. In some cases, however, the Division may ask the company or its personnel for documents or testimony relevant to the investigation, in which case the company would become aware of the investigation. Nothing in the Act precludes the auditor from informing the public company client of the existence of a Board investigation, but the Board cannot force the auditor to do so.
How should enforcement against audit firms be done? Should you take point? Or work in tandem with the SEC? What about the New York attorney general jumping on Ernst & Young?
The PCAOB may coordinate its auditor investigations with numerous other regulators enumerated in the Act. Most of the PCAOB's investigative coordination occurs with the SEC. Both the PCAOB and the SEC have jurisdiction over the audits of issuers, brokers, and dealers. As required by the Act and as a matter of practice, the PCAOB Enforcement Division coordinates closely with the SEC. The PCAOB frequently conducts investigations and disciplinary proceedings against auditors and audit firms without any direct involvement of the SEC (although the PCAOB staff keeps the SEC staff informed of its enforcement activities). As a result of its investigative experience focusing exclusively on auditors, the PCAOB has developed unique expertise in such matters, and the SEC has the opportunity to rely on that expertise as it deems appropriate.
In other situations, the PCAOB may bring a disciplinary proceeding against the auditor, and the SEC may bring an SEC enforcement proceeding against an issuer. Because the SEC has concurrent jurisdiction over auditors, there are also situations in which the SEC conducts investigations and institutes enforcement proceedings against auditors on its own. Finally, there are instances in which the SEC and PCAOB may institute parallel disciplinary proceedings against auditors. That was the case with recent sanctions against audit firms based in India.
As to the question about the New York attorney general, because our investigations are confidential under the Act, we cannot comment on whether we are conducting an investigation on a specific matter.
How can I, a U.S. company, be sure my auditor is exerting proper control over foreign audit firms inspecting foreign operations?
Under applicable audit standards a principal (or signing) auditor that relies on the work performed by another audit firm (in the U.S. or elsewhere) has certain responsibilities to obtain information about the other firm's professional reputation and independence, among other matters. Depending on the degree of involvement and responsibility assumed by the other firm, the principal auditor also may have to review and retain certain types of information from the other firm's audit work. However, depending on the circumstances, the principal auditor may not have to disclose in its report the fact that it relied on another firm to conduct certain audit work.
Despite the applicable requirements, PCAOB inspectors have found obvious errors that could have, and should have, been picked up by the principal auditor if communication between the two auditors had been more robust. Inspectors also have found unresolved audit issues between affiliates. One of the Board's priorities in its inspections this year is evaluating the quality of communication and coordination among affiliates in global networks. Inspectors will examine firms' supervision of work performed by affiliated firms, including firms' controls over consultations on accounting and auditing issues, as well as engagement teams' use and evaluation of affiliates' work.
Based on its findings, the Board is planning to consider any appropriate changes to the auditing standard on the principal auditor's use of other audit firms.
I would encourage you to discuss with your auditor the use of any other firms and the working relationship between your auditor and any foreign firms involved in the audit. You also may want to determine the identities and locations of such firms. The PCAOB Website includes a variety of relevant information, such as information about jurisdictions where we cannot conduct inspections, information about what firms have been inspected, and inspection reports for firms whose inspections have been completed.
What criteria do you use to select an audit for inspection? Which audit firm has had the most significant issues?
The selection of issuer audits for review is influenced by an evaluation of the risk that issuers' financial statements could be materially misstated. This risk might relate to characteristics of the particular issuer or its industry; the audit issues likely to be encountered; considerations related to a particular firm, practice office, or individual partner; prior inspection results; and other factors. In many cases, only a portion of an audit is inspected. The Board issues public inspection reports on each inspection conducted, which may be found on the PCAOB Website.
As a watchdog group whose role was recently under fire, how can you take a hard line about firm deficiencies without coming under fire again? Do you feel compelled to play nice in the “sandbox”?
Although the Supreme Court's decision in Free Enterprise Fund v. PCAOB invalidated a provision of the Sarbanes-Oxley Act dealing with the removal of PCAOB Board members, the decision did not affect the PCAOB's structure or programs, and the Board's activities have continued without interruption. The Board continues to be focused on taking appropriate steps in its inspection and enforcement programs, as well as standard-setting activities, in order to improve audit quality and enhance protection of the investing public.
We've seen the SEC raked over the coals several times for “regulatory capture”—do you worry that the PCAOB has a similar revolving door that undermines the mission?
Given the specialized nature of the PCAOB's work in connection with the oversight of public company auditors, the Board's staff by necessity includes individuals with experience conducting public company audits. Some of these individuals return to the practice of public accounting after working at the PCAOB as a natural step in their career progression. However, the Board and its staff take seriously the restrictions imposed on PCAOB staff conduct by the Sarbanes-Oxley Act and the PCAOB's Ethics Code, some of which continue to apply after individuals cease to be employed at the Board. Former employees are prohibited from practicing before the Board for one year after leaving Board employment and permanently barred from practicing before the Board with respect to any particular matter in which the former employee participated personally and substantially while employed at the Board.