More audit transparency for investors makes a bitter proposal easier to swallow

Via The Conversation

The Public Company Accounting Oversight Board (PCAOB) has recently announced a binding federal law that requires the disclosure of the name of the person who oversaw an audit of a company’s books. This is one of the most significant changes to auditing standards in the last 30 years and could have a significant impact on investors. 

The new rule is seen as a balanced alternative to the other approaches proposed in recent years, and could help investors assess the quality of a corporate audit. It could also be beneficial in times of stock market turmoil or when accounting scandals reach the headlines, as investors can be more informed about who is responsible for the financial information they are relying on. 

Despite objections from auditors, this new rule is necessary and should be accepted. It is important for investors to have confidence in the financial information they use to make investment decisions, and this proposal could help to provide that assurance.

The PCAOB plan

The Public Company Accounting Oversight Board (PCAOB) has proposed a new approach to protecting investors’ interests. The proposal seeks to include the name of the auditor who prepared the report in a separate form, Form AP, which will be posted to the PCAOB website and be fully searchable. This is an improvement over previous proposals that would have required auditors’ names and signatures to be included directly in the report itself. Auditors had valid concerns about increased risk of being sued by unhappy investors, while proponents argued that increased personal liability would improve audit quality. However, I disagree with the proponents as audit partners already understand the risks of regulatory censure and litigation under existing rules.

Problems with the approach

The Public Company Accounting Oversight Board (PCAOB) has stated that its goals are transparency and increased accountability. However, the reality of the audit process is that it is not performed by one person, but rather by a multi-member engagement team supported by a quality review partner, internal specialists, consulting partners and the entirety of the auditing firm. Naming the signing partner would put too much focus on one individual and would not provide the transparency the PCAOB desires. 

Auditors are already acutely aware of their responsibilities and there are more-than-adequate methods in place to maintain accountability, such as inspection processes, enforcement by the Securities and Exchange Commission, peer review, internal firm inspections and private litigation. Furthermore, there are concerns that the disclosed partner names may be misinterpreted or misused, and attributing accountability to one individual is too simplistic and often unfair. 

Research cited by the PCAOB in previous proposals is of limited value, as it involves primarily private companies located outside of the United States. For example, one study often cited by the PCAOB includes only statutory audits of private companies in Sweden. This is not representative of public companies and the litigious environment that exists in the United States today. The limited research in these studies does not appear to indicate any significant impact on audit quality when the partner is named.

Plan still boasts benefits

The Securities and Exchange Commission (SEC) has proposed a new rule that will require audit firms to disclose the names and locations of any other firm that provides at least 5% of the total audit hours for any given report. This includes affiliates and non-affiliates of the primary (signing) firm. This is a significant change, as it will allow investors to understand which public accounting firms are actually performing the audit work and where they are located. This is especially important as many recent accounting fraud cases in the US have involved poorly supervised foreign firms performing low-quality audits. 

The new rule has the potential to improve audit quality, as investors will be able to make informed decisions about their investments if they are aware that the signing firm in the US is performing only minimal work while a foreign audit firm incurs most of the audit hours. This could lead to a greater level of confidence in the audit report, and could lead to better investment decisions. 

The SEC’s proposal should be supported for continuing to seek a reasonable compromise on a contentious topic in the face of significant criticism. This new rule will provide investors and the public with greater transparency and assurance, and could lead to improved audit quality.

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