Reforms of the Auditing Profession; Improving Quality, Transparency, Governance and Accountability

Transcription

1 Refrms f the Auditing Prfessin; Imprving Quality, Transparency, Gvernance and Accuntability Beginning with the passage f the 1933 Securities Act, Cngress has required an Independent Audit fr every public listed cmpany in the United States. At the time the 1933 Act was debated by Cngress, it was discussed as t whether t have audits perfrmed by emplyees f the gvernment. Banks regulated by the Federal Reserve, Office f the Cmptrller f the Currency (OCC), and Federal Depsit Insurance Crpratin (FDIC) are all examined by gvernment emplyed banking examiners. But in the end, the draft f the 1933 Act was mdified t have the audits perfrmed by a licensed accuntant (CPA) wh is independent. Tday CPA s wh audit publicly listed cmpanies are currently regulated by bth the Securities and Exchange Cmmissin and its Office f the Chief Accuntant, and the Public Cmpany Accunting Oversight Bard (PCAOB). Cntinuing Issues with Pr Audit Quality There cntinue t be issues with the quality f audits perfrmed by CPA s. In Octber, 2008, a U.S. Treasury Cmmittee n the Auditing Prfessin (ACAP) issued a reprt with many recmmendatins fr the SEC, PCAOB, and auditing prfessin. This cmmittee f business leaders, investrs, frmer SEC regulatrs, and CPA s studied the prfessin fr a year befre issuing its reprt. Yet tday, ten years later, few f the recmmendatins have been acted upn by the audit firms, r their regulatrs. As a result, it appears the fur large audit firms have becme tw big t fail. And many f thse wh are regulating the audit firms at the SEC r PCAOB have jined the regulatrs frm these Big 4 firms, and have returned t them, as highlighted in the recent actin f the Department f Justice against auditrs at KPMG. Cntinuing issues affecting the credibility and trust in the auditing prfessin includes: Lack f Independence Auditrs view management f cmpanies they audit as their client nt the public. Management prvides them business pprtunities t grw their revenues/prfits. Management writes their check. T ften, in reality, audit cmmittee s delegate hiring and versight f the auditr t management. Auditrs have testified under ath in curt, that they d nt have an bligatin t detect material financial statement fraud and serve the public interest. The gvernment mandates management and the cmpany MUST buy audits, rather than thse wh actually wn the cmpany. In this respect, auditing f publicly listed cmpanies is like a publicly mandated utility. Lack f Transparency with respect t Audit Firm Perfrmance and Audit Quality. Investrs are nt prvided infrmatin necessary t infrm them as t the quality f the audit f the financial statements and disclsures f the cmpany they invest in and wn. In that regard, investrs are being asked t vte and ratify the auditr withut infrmatin necessary t making an infrmed decisin. Investrs are cnsistently tld in the audit reprt that audits have been dne in cmpliance with generally accepted auditing standards set by the Public Cmpany Accunting

2 Oversight Bard (PCAOB), a misleading statement in light f the very high deficiencies in cmpliance with GAAS reprting by the PCAOB and ther audit regulatrs arund the glbe. Lack f Independent Gvernance. The large audit firms, which audit the vast majrity f publicly listed cmpanies in the US as well as arund the glbe, all lack meaningful independent gvernance. This lack f gvernance, which is required fr publicly listed cmpanies, has resulted in a lack f quality, accuntability, transparency, and gvernance when it cmes t audit quality and perfrmance. Very pr audits quality based n inspectin reprts frm arund the glbe s bad that the Internatinal Frum f Independent Audit Regulatrs (IFIAR) called senir leadership frm each f the six largest firms in t discuss the pr audit quality. IFIAR s Glbal Audit Quality (GAQ) Wrking Grup and the GPPC netwrks undertk an initiative aimed t reduce the frequency f inspectin findings. In accrdance with a target established by the GAQ Wrking Grup, the GPPC netwrks seek t imprve audit perfrmance, reflected in a decrease f at least 25%, n an aggregate basis acrss the GPPC netwrks ver fur years, in the percentage f their inspected listed PIE audits that have at least ne finding. (See The 2016 Inspectin reprt f IFIAR stated: Inspected audits f listed public interest entities (PIEs) with at least ne finding remained unacceptably high at 42%. (See wpdmdl=2055&ind=0wstipxewb7d8mx8xq3ntxdi2mrfrpnjyc5ah9x9efm5lz7ea5dcculypcay7l snzwxgkvstcmqf4zvyayq1aak-gb4bllblz5jhgz1bardgils4x9iklcmrnhgra0gi&#zm=100) Audit firms ften state the deficiency rates are high because the regulatrs are picking high Risk audits which in sme, but nt all instances, is true. Hwever, ne wuld expect the audit firms t assign these audits t their very best auditrs, and as a result, there wuld be fewer deficiencies. And finally, audit reprts have failed t cnvey t investrs as well as audit cmmittees cncerns f the auditr, even when they knw management and cmpanies are vilating laws and regulatins. Such reprts are required fr auditrs f gvernments that receive federal funds, but are nt required in instances such as seen in recent years, fr audits f cmpanies such as Wells Farg. Refrms t establish accuntability t investrs as wners f the cmpany, enhance transparency and accuntability Belw are ideas t address the issues with pr audit quality n audits f publicly listed cmpanies. Sme f these ideas r recmmendatins were put frward ten years ag by the U.S. Treasury ACAP. Remve the current requirement in the Securities Laws that a Cmpany must have an audit by an independent auditr, thereby eliminating the federal gvernment mandate. Replace it with a market based requirement, that every 5 years, a sharehlder prpsal be included in the annual prxy, asking if the investrs want an independent audit f the financial statements by the independent auditrs. Accrdingly, it wuld be made clear that independent

3 auditrs wrk fr, and serve the public interest f the wners f the cmpany the investrs. I wuld expect that investrs mst ften wuld vte fr an independent audit, unless they saw little value in having ne. If the stckhlders d apprve the independent audit requirement (and again, I think they almst always wuld): The audit cmmittee, nt management, wuld select and nminate the auditr. This respnsibility culd nt be delegated t management; The stckhlders wuld then be asked t vte n and apprve the auditr; The audit cmmittee, nt management, wuld then be tasked with and respnsible fr negtiating the fee t be paid t the auditr; The audit cmmittee wuld submit a bill fr the audit fee t the PCAOB as necessary during the curse f the audit. The PCAOB wuld cllect a fee frm each public cmpany t cver the bill f the auditr fr the audit. The PCAOB already has a mechanism in place fr cllecting fees it is required t get frm public cmpanies The PCAOB culd require a cmpany t tender their audit fr prpsal, if the PCAOB fund the auditrs had engaged in imprper prfessinal cnduct as defined in SEC Rule 102(e), r had a material weakness in their wn internal audit quality cntrls; r had significant deficiencies n an audit in which the auditr had failed t cmply with GAAS as set by the PCAOB. In n event, culd the audit firm serve as auditr fr a publicly listed cmpany fr a perid lnger than what is permitted tday by the EC which is 20 years. The new auditr reprt adpted by the PCAOB shuld be required n all audits f public cmpanies. This new audit reprt will require the auditr t state and discuss in this new frm f audit reprt, critical audit matters (cmmnly referred t as CAMS). The new audit reprt als requires the auditr t state: A statement that PCAOB standards require that the auditr plan and perfrm the audit t btain reasnable assurance abut whether the financial statements are free f material misstatement, whether due t errr r fraud. Hwever, the PCAOB exempted a wide swath f public entities and did nt require cmmunicatin f critical audit matters fr audits f emerging grwth cmpanies ("EGCs"), brkers and dealers reprting under the Securities Exchange Act f 1934 (the "Exchange Act") Rule 17a-5; investment cmpanies (e.g., mutual funds), ther than business develpment cmpanies; and emplyee stck purchase, savings, and similar plans ("benefit plans"). If auditrs thrugh their audit wrk, becme aware f a cmpany r management breaking a law r regulatin, that culd have a material impact n the financial statements r peratins f a cmpany, they shuld be required t disclse it in their reprt, just as an auditr f a gvernmental agency subject t the GAO Yellw Bk auditing standards is required t d s. Require disclsure f audit quality indicatrs fr each audit n which an pinin f the auditr is prvided t investrs in the cmpany. These indicatrs shuld be disclsed in the Cmpany s prxy as part f the Cmpany s audit cmmittee reprt t investrs. Audit cmmittees shuld

4 als be required t disclse either in the prxy, r in the Charter f the Cmmittee, the cmmittees prcedure fr peridically tendering the audit. Audit firms shuld already be measuring audit quality n individual audits if in fact they are managing audit quality. But the audit inspectin results frm arund the glbe prvide sme evidence, that has nt be ccurring. The PCAOB inspects a very small percentage f the audits f publicly listed cmpanies each year, and prvide a public inspectin reprt fr each firm with their findings. Fr thse audits inspected, the PCAOB inspectin reprts are perhaps the best indicatr f audit quality tday. Yet the PCAOB has refused t prvide the name f cmpanies being audited, stating the Sarbanes-Oxley Act f 2002 (SOX) prhibits this. But that is false as there is nt language in SOX that prhibits the disclsure f the name f the cmpanies whse audits are inspected. What SOX des prhibit is disclsure f investigatins and enfrcement actins taken by the PCAOB with respect t a pr audit. Senatr Sarbanes agreed t an amendment f the then draft f SOX (May 2002), t include a prhibitin n public disclsure, until the PCAOB enfrcement actin is final, at the request f the audit firms and Senatr Enzi wh was negtiating n their behalf. Harvey Gldschmid, wh wuld shrtly thereafter becme an SEC Cmmissiner, and I, pleaded with the Senatr nt t make this change, as enfrcement actins taken by the SEC are nt private, but are in fact public. Senatr Jack Reed (D-Rhde Island and Grassley (R-Iwa) have intrduced subsequently intrduced legislatin, supprted by the PCAOB in the past, t reverse this change and make the actins public. Unfrtunately, in the meantime, the audit firms have used this prvisin f SOX t hide and appeal and delay the actins until many years have gne by. Then the audit firm always makes a public statement that in essence says a final PCAOB actin is years ld and shuld be ignred. Currently the law requires that an audit partner be rtated ff as the lead audit partner fr a cmpany, after n lnger than five years. This is t prvide a fresh set f eyes t the audit accrding t the cngressinal recrd. Yet there can be a number f audit partners n an audit, and it is nt uncmmn, t find the lead partner rtated ff, and ne wh has been n the audit in the past, rtated int the lead audit partner psitin. As a result, there are incentives fr partners nt t bring up new prblems frm the past. Given the refrms cited abve, this requirement, which has significant csts assciated with it, culd be eliminated. Require each auditr f public cmpanies t issue an annual reprt, just as the cmpanies they are required t audit must, cntaining its: Financial statements prepared in accrdance with generally accepting accunting principles (GAAP). This is imprtant t assessing the financial health f these firms as they have becme t big t fail as demnstrated by actins f law enfrcement agencies and regulatrs. A discussin f the firms quality cntrls regarding all aspects f the audit including independence, human resurces such as hiring, training and supervisin, perfrmance f audits, selectin and retentin f cmpanies they audit, and testing and enfrcement f the quality cntrls. A discussin f the firm wide, as ppsed t individual audit engagement, audit quality indicatrs. A discussin f the firm s gvernance structure, prcess and prcedures.

5 The Eurpean Cmmissin already requires each f the large audit firms t prvide a reprt with sme f this infrmatin. The US audit firms d publish an annual reprt n their wn, but it disclses very limited financial infrmatin, and limited infrmatin n gverning structures, accuntability f executives, and perfrmance measurement and imprvement. Audit firms that audit mre than 100 public cmpanies shuld be required t have independent directrs r members n the firm s gverning bard. Audit firms need t abandn the Pyramid scheme they use fr staffing tday, and adpt a paraprfessinal mdel used in law firms. The pyramid structure has resulted in talented, but yung and inexperienced staff assigned t perfrm audit prcedures, with respect t business transactins the staff are ill prepared t examine and challenge. All CPA s shuld be required t have a master s degree in accuntancy. I believe the master f prfessinal accuntancy prgram is srely needed. The actins f the large audit firms in which they encurage students t leave schl and begin their careers befre the student receives their master is disappinting in that it Highlights the lack f cmmitment t educatin by thse firms. Actins speak luder than wrds. The SEC shuld revise its definitin f what is a financial expert n the audit cmmittee and adpt its initial prpsal. The SEC shuld clarify the audit cmmittee MAY NOT delegate this respnsibility t the management f the Cmpany, which is ften dne tday.