PCAOB Position: Trust but verify…and then don’t trust???

The International Auditing and Assurance Standards Board that sets auditing standards on a global basis has issued a new standard effective December 15, 2016, requiring that engagement partners physically sign the audit report with their names instead of the name of the firms, as is done in the United States. The ethical question is whether this is the right thing to do in the U.S.? After all, if it is not or is unlikely to make a difference with respect to audit efficiency and effectiveness, then why do it?

Those who argue for the change believe it will hold auditors accountable for their work and protect the public interest. Those who argue against it say because more than one partner is typically involved in an engagement, why signal out the engagement partner to sign the report? Moreover, there may be unintended consequences as discussed below.

In the U.S., the Public Company Accounting Oversight Board (PCAOB) has been discussing this issue for some time and back in September 2014 it proposed the following should be disclosed:

• The name of the engagement partner
• Any independent public accounting firms involved in the audit, as well as their locations and what they contributed
• The location, as well as extent of contribution, of any individuals not employed by the auditor who took part

Proponents assert that requiring disclosure would motivate auditors to do a better job and remind them of their responsibility to the public. In addition, proponents contend that the greater visibility would eventually make investors more capable of assessing audit quality and performance.

The U.S. Council of Institutional Investors (CII) is a strong proponent of the idea of having the auditor sign the report, The CII view is that disclosure in the auditor's report of the name of the engagement partner would facilitate the ability of shareowners to obtain useful information about the track record of lead audit partners. This is "information that many investors demand and deserve to know,” CII believes.

According to PCAOB chairman James Doty: "All the major markets, except the US have such a signature requirement. Auditors are living with it in most countries around the world except here," Doty said. “By knowing who the engagement partner is, investors would be able to track certain aspects of the individual engagement partner’s history, including his or her industry expertise, restatement history, and involvement in disciplinary proceedings or other litigation. All of these factors provide valuable information for an investor to fully understand the riskiness of an audit. And it sharpens the mind.”

As for the audit firms, they are against it. Back in 2013 when the proposal was first made public, the Center for Audit Quality (CAQ) warned of adverse outcomes. The CAQ emphasizes that engagement partners must answer to their employers, regulators, firms, audit committees and investors already. CAQ believes these multiple layers of accountability provide a significant incentive for engagement partners to conduct high quality audits in accordance with professional standards.

Big Four firms lament the need for such a proposal and possible unfair series of lawsuits targeting just one auditor, the one who signs the report. Audit firms point out that several partners are involved in formulating the final opinion including the lead audit partner, the engagement partner, a technical review partner, and the managing partner of the firm. Firms also point to secrecy issues in their response to the proposal.

PwC sent a letter to the PCAOB in response to its initial proposal in 2009 that reflects the views of the audit profession and can be considered a valid view with respect to the 2014 proposal. PwC opines that the premise of PCAOB proposal is faulty, that is, the engagement partners [partner signing the report], as a class, need to have an increased sense of accountability in order to achieve improved audit quality.

The main points made by PwC in its 2009 letter are summarized below.

• The notion that having an engagement partner sign the audit report would enhance audit quality because it might increase the engagement partner’s sense of accountability to financial statement users, which could lead the partner to exercise greater care in performing the audit ignores the many quality controls used by the firm already to ensure accountability.
• Incentives already exist to ensure that the engagement partner – along with other members of the engagement team and the firm as a whole – conduct the audit with the necessary due care and professionalism.

First, let me say it is disingenuous of PCAOB chairman James Doty to argue: "All the major markets, except the US have such a signature requirement” and that is why it should be adopted in the U.S. The fact is we could say the same thing about International Financial Reporting Standards (IFAC) that have been adopted by about 120 countries but not the U.S.

Second, the AICPA Code and PCAOB audit, independence, and ethics standards already hold in check bad behavior by the firms and all of its partners. Moreover, PCAOB inspections serve as a counterbalance to any improper behavior or negligent actions by partners who sign the report or otherwise. It almost seems to be a punitive measure and knee-jerk reaction by the CII (and PCAOB) to a rash of audit failures in the early 2000s.

To think that an auditor(s) needs to have his or her name explicitly stated to follow all the prescribed standards is borderline offensive. CPAs are professionals and by and large take their responsibilities seriously. Signing the audit report with one’s name will not increase that commitment and may introduce an element of uncertainty and risk not warranted given internal controls already in place to ensure exactly what the PCAOB says it is trying to accomplish with its proposal.

Finally, an important distinction is that in Europe auditors are appointed by shareholders and shareholders approve their remuneration. In the US the audit and accounting standards are not seen as a shareholder accountability mechanism but a market accountability mechanism. These differences argue against the need for single auditor signatures.

Blog posted by Dr. Steven Mintz, aka Ethics Sage, on October 29, 2015. Professor Mintz teaches in the Orfalea College of Business at Cal Poly San Luis Obispo. He also blogs at: www.ethicssage.com.