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PCAOB May Face Long Odds Completing Audit Quality Indicators Project

November 2, 2022

In response to investor advocates’ demand, the Public Company Accounting Oversight Board (PCAOB) added “firm and engagement performance metrics” to its research agenda, which is a resumption of a long-stalled project to develop a set of measurements to assess the quality of an auditor’s work. It was originally called the audit quality indicators (AQIs) project.

However, the PCAOB’s decision fell short of expectations to at least one adviser to the board because the project was not put on its standard-setting agenda, given that prior board had issued a preliminary rulemaking release in 2015 following a couple of years of research. The PCAOB soon after had set it aside because of strong resistance by audit firms.

The board revealed its updated agenda with the research project on Oct. 12, 2022.

“This is nothing short of a delaying tactic,” former SEC chief accountant Lynn Turner said in an interview. “This is a slap in the face of investors.”

Turner is a member of the PCAOB’s two advisory groups. To investors, AQIs are important because if audit firms “are not measuring it, they can’t be managing it,” Turner added.

Following leadership change at the PCAOB late 2021 and early 2022, the board in May refreshed its standard-setting and research agendas. Undoubtedly, the standard-setting agenda is ambitious with many more projects with a shorter timeline, at least compared to the previous board led by William Duhnke. He was criticized for being too lenient to the auditing profession, among other problems.

However, many investor advocates were disappointed that they did not see AQI on the refreshed agenda in May and publicly pressed the board in June to finish it as soon as possible.

Congress established the PCAOB with an explicit mission of protecting investors to try to prevent a recurrence of large accounting scandals that toppled companies like Enron and WorldCom two decades ago. At the time, Enron’s bankruptcy was the biggest in the United States.

And AQI was one of the several recommendations in a report issued by the Treasury Department’s Advisory Committee on the Auditing Profession (ACAP) in 2008. The PCAOB has implemented some other recommended reforms from the report, such as expanded auditor’s report, but others such as AQIs and fraud prevention, have had little progress.

During a meeting of the PCAOB’s Investor Advisory Group (IAG), which was held on the same day the board made its updated agenda public, Turner provided a little bit more background on the AQI project as he was a member of ACAP.

“The ACAP took it up because there’s some view amongst the people from the business world that if public companies had to be transparent, then the audit firms who are key components of the capital market system needed to be equally transparent, and ACAP requested a bunch of information from the firms, which they declined to provide some of it,” Turner said during the IAG meeting on Oct. 12. “So, then the ACAP got some written input as well as public testimony on this issue. I thought it was important, and it became part of our recommendations at the time.”

He then explained that accounting firms were more focused on providing firm-wide reports, which do not provide useful enough information about whether a particular audit was high quality or not. Investors want engagement-level AQIs.

“But then, as with many of the projects, nothing ever happens,” Turner continued. “This is something that’s been discussed, debated frankly beat to death. And we did find out that [during] KPMG trial that the PCAOB is actually gathering some extremely useful and helpful information…, which is probably why the firm … tried to get ahold of that information so they could make their audits look better. So, I think that was a telling story and a piece of the puzzle.”

Turner was making a reference to the PCAOB audit inspection cheating scandal involving now-former KPMG partners and former audit regulatory board officials.

He said he is worried that this is yet again on the research agenda because he has listened to the AQI presentations for 18 years now. “Things have come and gone but progress on them has been exceedingly slow and painful.”

In response to Turner’s criticism during the IAG meeting, PCAOB Chair Erica Williams assured him that the board is serious about advancing the project.

“I appreciate the background very much, Lynn. It’s very useful especially for this board, which is relatively new, to hear directly from you about your experience in the past,” Williams said. “And I just want to make clear that the research agenda that this board has put forward is different. There are projects on there, they’re not going to stay on our research agenda for more than a year. And by placing this project, key performance metrics, on our research agenda, it is a signal that this board is actively working to move it and that we are very serious about getting it done. And my plan is to move it to the standard-setting agenda in 2023 and advance it from there. So, I do understand the history. We do want to learn that history here especially from this investor advisory group and make sure that we get it right.”

Turner seemed skeptical that the PCAOB could wrap up the project because of elections, especially the general election in 2024, following which administrations could change. In his view, the AQI project needs to be completed before then because potentially new leaders at the SEC and the PCAOB will have different views.

“What you are talking about is having to move it off the agenda into standard-setting and then completed by 2024,” Turner said. But “we could be having the same discussion with a whole new group after that, hopefully not. But given recent history, it would tell us that that would be the case.”

Moreover, the mid-terms next week could also have far-reaching consequences if the Republicans get control of both chambers. Some Republicans want to transfer the PCAOB’s functions to the Securities and Exchange Commission, which oversees the board.

Long-Stalled Project

After issuing Release No. 2015-005, Concept Release on Audit Quality Indicators, in July 2015, the PCAOB shifted to monitoring mode, citing audit firms’ voluntary actions in the area.

In reality, the PCAOB at the time put a brake on the project after auditors—and audit committees to a lesser extent—never fully supported the initiative. The comment letters by the audit firms tended to question why the indicators were needed through a regulatory initiative if accountants could address them through firm-wide policies. In their view, indicators should be tailored and customized to particular audits to be useful.

In particular, they said quantitative measures mean little without qualitative discussions of a particular audit. They also said some indicators, in particular the measures that deal with specific audit engagements, should not be mandated or made public. Auditors and audit committees were concerned that the public might overreact to the information without proper context.

But Investors said they are fully capable of evaluating the measures. They also viewed the indicators as an important piece of a more far-reaching plan to use regulations to strengthen auditors’ independence from their clients.

Some large investor groups believe the indicators could give them meaningful information when considering their votes to ratify the external auditor and elect the chair of the audit committee.

Release No. 2015-005 lays out 28 indicators, covering three broad categories dealing with audit professionalism, process, and results.

Now towards the end of 2022, the rebranded project’s objective, according to the PCAOB website, is to “assess whether there is a need for guidance, changes to PCAOB standards, or other regulatory actions in light of the increased disclosure and demand for firm and engagement metrics. This includes evaluating metrics already disclosed by Firms to audit committees and the public. Our research includes taking into account data from our oversight activities, firm current practices, and global initiatives in other jurisdictions by regulators, oversight bodies, professional bodies, and others.”

[Thomson Reuters]

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