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Tougher PCAOB Enforcement Agenda Ahead


By Richard J. Morvillo and Jeffrey F. Robertson


Even as the Supreme Court heard argument concerning the constitutionality of the Public Company Accounting Oversight Board (PCAOB or “the Board”), the PCAOB quietly proposed a five-year strategic plan and budget for 2010, which the SEC subsequently approved. These actions reveal plans for an expanded mandate that seems likely to result in more enforcement referrals and investigations, especially as relate to the Big Four accounting firms.


Sarbanes-Oxley requires that the PCAOB annually outline its strategic initiatives for the next five years. In general, the broad initiatives and goals embodied in the PCAOB’s most recent strategic plan differ little from those of its prior plans. For instance, its new plan notes that the PCAOB will strive to provide effective oversight of registered accounting firms, inform investors of its activities and coordinate efforts with other domestic and international regulators. More telling, however, is the PCAOB’s discussion of the “key environmental factors” it confronts. This discussion reveals a great deal about what we should expect in the coming years, and particularly the following:


Increased PCAOB enforcement activity due to the global financial crisis. The PCAOB’s strategic plan notes that changes in economic and business conditions during the past 18 months have made auditing more difficult, particularly as relates to valuation, impairment and going concern evaluations that require significant estimates and judgments. Due to these developments, the PCAOB’s own inspections are more challenging and reinforce the need for thoughtful risk assessment. Financial hard times have resulted in increased referrals to the PCAOB’s Division of Enforcement and Investigations, a trend that seems likely to continue as the impact of the global financial crisis spreads from financial services firms to other market participants.


Expanded PCAOB mandate. Following disclosure of the Madoff Ponzi scheme, auditors of the nation’s 5,500 non-public securities broker-dealers are now required to be registered with the PCAOB. (As of Dec. 30, 2008, the SEC terminated the exemption from the PCAOB’s registration and reporting requirements for audit firms with broker-dealer audit clients. As a result, financial statements of all broker-dealers for fiscal years after Dec. 31, 2008, must be certified by a PCAOB-registered public accounting firm.) Legislation pending in Congress will extend the PCAOB’s inspection, enforcement and standard-setting responsibilities to include auditors of broker-dealers. (On Nov. 4, 2009, the House Financial Services Committee reported out H.R. 3817, the Investor Protection Act (IPA). Section 601 of the IPA would expand the PCAOB’s oversight responsibilities to include audits of the financial statements and selected practices and procedures of broker-dealers.) These developments mean the number of audit firms the PCAOB oversees will increase by roughly 1,200, a 50 percent jump.


Continued scrutiny of risks involving Big Four firms. The PCAOB’s strategic plan observes that “four very large firms” audit 97.8 percent of the global market capitalization of public companies whose securities trade on U.S. exchanges. According to the PCAOB, this concentration presents a “special risk” because an “audit failure by one of these firms, especially in connection with a large issuer client, could have significant negative effects on the firm, including possible negative effects on the firm’s ability to continue to serve as the auditor for its many other” clients. The PCAOB concludes that, in a post-Arthur Anderson world, there is a real risk that a single audit failure could lead to the downfall of a an entire audit firm. Even more troubling is the PCAOB’s description of its hands-off role vis-á-vis these firms, stating: “The PCAOB’s mission is not to protect an individual firm from demise . . . The PCAOB aims to protect investors from the risk of a significant and abrupt change in the availability of audit services due to a firm’s demise. But in the event that a firm nevertheless fails, the PCAOB could find it necessary to work closely with the SEC to protect investors as audit clients transition to another firm.”


Challenges of international investigations. PCAOB inspections and investigations outside the United States require substantial PCAOB resources and present unique issues. Registered public accounting firms with U.S.-based multinational audit clients often rely on global networks of firms that frequently share a common name and certain policies, practices, audit methodologies and business interests. Yet many of the non-U.S. registered firms are subject to inspection in countries that have established local auditor oversight systems. In some cases, the PCAOB has found it difficult to secure the cooperation of local authorities to permit it access to work papers of non-U.S. firms to complete the PCAOB’s inspections. Though pending legislation in Congress may remedy this problem, the PCAOB’s inability to share information from its inspections with its local counterparts has decreased the willingness of local authorities to cooperate with the PCAOB.


Leadership changes may alter the PCAOB’s focus. The PCAOB, in addition to responding to changing oversight by the SEC and its new chair, expects to replace all but one of its current members, including its chair, within the next year or so. The priorities of these new members could alter the PCAOB’s strategic goals, objectives and initiatives.


2010 PCAOB Budget
Perhaps anticipating an expanding role, the PCAOB proposed and the SEC approved a PCAOB budget that is substantially larger than its current budget. The approved budget reflects the following:


  • A 16 percent funding increase, to $183 million annually.
  • A projected 10% increase in staffing, to 636 employees, by year-end 2010.
  • Funding increases focused on the PCAOB’s Division of Registration and Inspections (up $17.4 million, or 25 percent) and Division of Enforcement and Investigations (up $2.8 million, or 23 percent), respectively.

In a statement issued in connection with the PCAOB’s budget proposal to the SEC, PCAOB member Steven B. Harris justified the increased budget request this way: “Following a year in which investors incurred tremendous losses due to the financial crisis on Wall Street and in the housing markets, investors are looking to regulators, including the PCAOB, for reassurance about the quality of financial reporting in the marketplace and to see that their interest are safeguarded.”


Richard J. Morvillo and Jeffrey F. Robertson are with Schulte Roth & Zabel LLP in Washington, D.C.


 
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