Now that we're all settling back into the office, the compliance community has any number of serious issues looming in front of us this month. To my thinking, however, few have as much potential to change the compliance function's day-to-day workings as the Public Company Accounting Oversight Board's ambitions to reshape how the auditing industry works.
The PCAOB started that long-overdue conversation in June, when it published a concept release that floated various ideas to reform the auditor's report—you know, that bit of boilerplate at the end of your financial statements that can cost millions in audit fees every year. Then the board followed up with another concept release in August examining possible changes to auditor independence, including the hugely controversial idea of mandatory rotation of a company's audit firm every few years.
Next the PCAOB will follow up with a public roundtable on Sept. 15. The formal agenda is to talk about the concept release on the auditor's report, but somehow I suspect mandatory rotation and various other reform proposals will make a guest appearance in the discussion. Concrete changes to how external audit firms work with corporations won't arrive for a long while, of course, assuming the PCAOB even does enact substantial reform. Regardless, compliance and financial reporting officers should watch this debate closely as it unfolds.
Let's take one example from the concept release on the auditor's report: the prospect of having the audit firm opine on risks discussed in the Management Discussion & Analysis. On one hand, this is a good idea because it touches the root of what investors want these days: counsel. After all, the audit report doesn't exist to reduce the risk that an investor will lose money; it exists to reduce the risk that the investor will be surprised by the loss of money. The report says (usually) that a company's financial statements are reliable, and you the investor can therefore make proper decisions. The report is offering the counsel, “Yes, you can trust what this company is telling you.”
Investors want that same opinion about risks in the MD&A, too. But should the external auditor be the one to provide it? This is where compliance, risk and financial reporting officers should speak up—because it's a valid argument that somebody should help investors inject a dose of real insight into the standardized boilerplate that fills so much of the MD&A, but I can foresee all sorts of independence and liability questions arising if that someone is your audit firm. And I'm willing to bet that your audit fees would arise too.
The concept release exploring mandatory audit firm rotation is equally frustrating. I do believe that audit firms and their clients stumble into relationships that are too cozy, and the PCAOB should lead a discussion to figure out how to sever those bonds that grow too close. Mandatory rotation, however, seems like a draconian theoretical solution to what is essentially a people problem: firm partners and staff auditors becoming too friendly with corporate accounting departments.
One comment letter to the PCAOB, from Richard Hawley, CFO of Nicor Inc., said it well:
This proposal is built on the faulty premise that somehow the real audit work is performed by firms rather than the people within those firms. Existing rules governing personnel rotation, training, etc., are in place to ensure audit professionals are independent, objective and employ appropriate professional skepticism. If the PCAOB believes a problem actually exits in those areas, look to those rules; do not insert yourself into areas best left to the boards and management of public companies.
Hawley's point is a good one. The relationship between an external audit firm and its client company—healthy or otherwise—depends on the actual human beings who work together. If you want a strong, ethically sound relationship, you need strong, ethically sound human beings working together. That takes training and rules, as Hawley says. It does not necessarily take a regulatory diktat foisted onto corporate boards and audit firms regardless of the humans that work there.
Still, those are only two of many questions the PCAOB is trying to answer. And we should all support the PCAOB in its efforts, because the current model of auditor-client relationships is seriously flawed—and moreover, very expensive. We can all complain about the broken institution otherwise known as Congress, or the over-stretched Securities and Exchange Commission as it plods forth with implementing the Dodd-Frank Act. But ultimately compliance professionals deal more regularly with their auditors, and pay them more money. Compliance Week will be following the PCAOB's deliberations closely this fall. We all should.