The PCAOB’s Revised Research and Standard-Setting Agendas

In late 2017, the U.S. Securities and Exchange Commission (“SEC”) appointed an entirely new Board, giving the five new members the collective opportunity to develop a PCAOB 2.0. In 2018, we issued a Strategic Plan that promised innovative oversight, including with respect to our approach to writing auditing standards. Consistent with our statutory mission, we explicitly committed, in doing so, to consider the expectations of investors.

Last month, the PCAOB published its updated research and standard-setting agendas that will be its focus of attention and resources for the next 12 to 18 months. The agendas do not, however, reflect the promises made in the Strategic Plan.

With respect to investor expectations, the revised agendas mostly disregard them. The agendas removed matters repeatedly identified by investors as important—matters that have only grown in significance in a COVID-19 environment. What remains largely overlaps with the priorities of an international standard setter. While these priorities may be good ones, the goal of global alignment and coordination should not take precedence over the expressed interests of U.S. investors.

As for innovative oversight, the revised agendas mostly leave in place the remaining legacy standards adopted by the PCAOB on an “interim” basis in 2003. These standards were written by the audit profession during the era of self-regulation, with little input from the public and were sharply criticized during Congressional hearings.

The need to revise these out-of-date interim standards has become even more pressing with the PCAOB’s ongoing consideration of changes to the standards governing quality control (QC) systems at audit firms. In our Concept Release published in December 2019, we suggested that firms’ QC systems could have as an objective conformity with our existing standards. Given the dated nature of these interim standards, this objective could establish a low bar that does not ensure the quality of audits expected by investors and the public.

The lack of adequate public participation by investors and the public weakens confidence and trust in the standard-setting process, which can harm our capital markets. Revisions of this magnitude and the imbedded policy decisions that they reflect should only occur after public debate, discussion, and feedback.

As a result, I do not support the changes made to the agendas.

I. The Revised Research and Standard-Setting Agendas

The Strategic Plan issued in 2018 (and again in 2019) promised that the Board would seek to “[u]understand and consider investors’ audit expectations” and, in doing so, we promised to “be more innovative in our oversight activities—particularly with respect to our approach to inspections and standard setting.” The revised agendas, however, fail with respect to both promises.

A. The Unfulfilled Promise of Investor Expectations

Since its formation, the PCAOB has regularly considered the expectations of investors in determining its standard-setting agenda. We did so by proactively soliciting feedback on their priorities and including topics identified through this process on the agenda. Often the input came through public meetings of the PCAOB’s two advisory groups.

Investors, for example, strongly supported standards that required identification of those participating in an audit (i.e., the required disclosure of the engagement partner, the firm’s tenure with a particular client, and the “other auditors” used in an audit) and the most difficult areas of an audit (i.e., critical audit matters). As a result of strong investor interest, participation and feedback, these matters were added to the standard-setting agenda and ultimately adopted by the prior Board.

With respect to the September 2020 revised agendas, there have been no public meetings of our advisory groups to discuss these changes or any other standard-setting matters. Rather than reflecting the interests of investors, the revised agendas remove the very matters that investors have repeatedly identified as important, including:

• An Auditor’s Role Regarding Other Information and Company Performance Measures, Including Non-GAAP Measures. Not meaningfully updated since the 1970s, this standard was written before the era of electronic filings on EDGAR, mandatory submission to the SEC of certain earnings releases, and the widespread use of sustainability reports and climate-related information (such as the recommendations of the Financial Stability Board’s Task Force on Climate-related Disclosure). Modernization of the standard is the gateway for a discussion about an audit firm’s role in providing assurance, if any, on non-GAAP measures, key performance indicators, XBRL tags, and metrics relating to ESG matters. The role of assurance for these matters has been a topic of global discussion, goes directly to the relevance of the role of the auditor, has increasingly been seen as relevant in the debate on the impact of climate change on financial disclosure, and has only grown in importance as a result of the current pandemic.
• An Auditor’s Consideration of Noncompliance with Laws and Regulations (NOCLAR). This standard addresses the obligation of firms with respect to illegal activity uncovered during an audit. The standard was adopted before the era of compliance officers and widespread use of whistleblower complaints and does not take into account high-profile cases involving serious violations of laws and regulations arising from operations rather than financial accounting and reporting. Comments from the PCAOB’s Investor Advisory Group indicated a desire to move forward on this matter “with some degree of speed. . .”
• Consideration of an Entity’s Ability to Continue as a Going Concern. The standard was added to the PCAOB’s agenda after discussion by the PCAOB’s Advisory Groups (IAG and SAG) and in light of changes to the financial reporting standards issued by the FASB. The impact of the COVID-19 pandemic on the global economy has reconfirmed the importance of this area and the need to ensure that requirements under the standard are sufficient to ensure proper treatment and disclosure by auditors.

The revised agendas do not adequately explain the reasons for the removal of these items or include any discussion of how investor concerns that caused them to be added to the agendas in the first place were addressed. Moreover, their removal and relegation to a status of “monitor[ing] relevant developments” is problematic in light of the particular importance of these areas in an economic environment deeply impacted by the continuing pandemic.

While deleting areas of importance to investors, the remaining items on the agendas overlap with the priorities of an international standard setter. Proposals by other standard setters are important and can be useful sources of input. The focus of the PCAOB, however, must be on the priorities of investors and the public rather than priorities of the other standard setters. In so doing, we will be far more likely to lead, rather than follow, in the global debate on auditing standards.

This apparent decision to give priority to other standard setters, as suggested in the revised agendas, deserves a full public airing rather than an isolated reference in our December 2019 Concept Release.

B. The Unfulfilled Promise of Innovative Oversight

The revised agendas are not innovative. With the exception of quality control, they fail to address the interim standards adopted by the PCAOB, leaving largely untouched the out-of-date requirements that do not adequately reflect the interests of investors and fail to take into account significant changes in the system of financial reporting that have occurred since the PCAOB opened its doors in 2003.

Congress created the PCAOB in part to remedy concerns over the standard-setting process. During the nearly 70 years of self-regulation by the profession, standards (or auditing rules) were determined by the profession without adequate investor input. Congress addressed these concerns by giving the PCAOB the authority to write standards and instructed that this be done in the interests of investors and the public.

The Board adopted, on an “interim” basis, the same standards that were written during the era of self-regulation and sharply criticized in Congressional hearings. An expediency, the decision was accompanied by a commitment to reexamine the standards “as soon as possible”. Nonetheless, seventeen years later, despite a very different auditing environment, many of these standards remain in place without material change.

The revised standard-setting agenda does include possible revisions to the standards on quality control. Moreover, the PCAOB issued a Concept Release last December seeking comment on possible revisions to these interim standards.

The Concept Release, however, suggested that the objective of a system of quality control could be to “provide a firm with reasonable assurance that its personnel comply with professional standards applicable to its accounting and auditing practice and the firm’s standards of quality.” In other words, the revised standards could have as an objective compliance with our existing outdated auditing standards. Until we update the other interim auditing standards, this objective could establish a low bar that would not ensure the quality of audits expected by investors and the public.

Certainly, a systematic re-evaluation of these interim standards would be a sizeable and time-intensive project. Our revised agendas, however, do not even hint at this need, much less suggest a timetable for doing so.

II. The Impact on the Capital Markets

There are very real consequences to the capital markets resulting from the lack of transparency around the decisions made in the revised standard-setting and research agendas and the failure to adequately take investor views into account through public meetings and public comment.

The PCAOB faces a serious transparency problem. Other than the meetings of our advisory groups, we rarely hold roundtables or other public meetings designed to debate, discuss, and obtain feedback on matters of importance to the PCAOB’s mission. Lack of transparency was a concern in the era of self-regulation and has yet to be fully remedied. Without adequate transparency, there cannot be adequate accountability.

Standard setting by the PCAOB was traditionally an exception to this approach. The PCAOB benefited from feedback provided in public meetings by its Standing Advisory Group, which consisted of a variety of stakeholders, including a large number of investors and investor representatives, as well as its Investor Advisory Group. Public meetings of these groups also helped inform and educate the wider investor community about the standard-setting process, thereby facilitating additional feedback and input.

We have not, however, held any public meetings of these advisory groups since November 2018, a hiatus of almost two years. Neither group has had an opportunity to publicly weigh in on the decisions to remove from the agendas the very projects that they asked us to include. Nor have they had an opportunity to address whether the PCAOB should emphasize the standard-setting priorities of an international body rather than the priorities that they recommended. In the absence of public meetings of these advisory groups, investors and other participants in the capital markets have not been sufficiently alerted to these possibilities or given adequate opportunity to provide feedback.

The most far reaching decision made by Congress in creating the PCAOB was to ensure that audit oversight would be done in the interest of investors and the public, effectively providing them with a guaranteed seat at the standard-setting table. The benefits of this approach are clear: Participation by investors adds credibility and accountability to the process, promotes confidence in audits conducted by independent accounting firms, and increases trust in the financial disclosure process.

The recent updates to the research and standard-setting agendas do not adequately reflect the views of investors. This is a tragic mistake. The absence of an adequate opportunity to participate through an open and public process may well weaken the credibility of, and confidence in, the efforts of the PCAOB and the audits of public companies and SEC-registered broker-dealers. The result will be less trust in our system of financial reporting, an outcome that harms our capital markets.

Revisions to the PCAOB’s project agendas should only be made after adequate public engagement with investors, including public meetings of our advisory groups. Were we to take these steps, the standard-setting and research priorities would likely be very different and better suited to the needs of investors and other participants in the capital markets.

The complete publication, including footnotes, is available here.