Defective Audits Are Not Being Adequately Dealt With
The SEC removed William Duhnke as chairman of the Public Company Accounting Oversight Board (PCAOB), the U.S. audit watchdog, on June 4, 2021. This raises serious questions about the relevance of the PCAOB today and whether it has been operating as intended. In other words, is it protecting the public interest against deficient audits? The SEC removed Duhnke and took steps to replace its entire board as the SEC's new leader, Garry Gensler, begins to shape the regulator.
A recently issued report slammed the PCAOB as being too lenient with the Big Four accounting firms over audit deficiencies, resulting in only $6.5 million in fines during its tenure, according to a new report.
The Project on Government Oversight (POGO), an independent watchdog, said its analysis of PCAOB annual inspection reports showed the board has in key respects been doing “a feeble job” policing the Big Four.
“It has taken disciplinary action over only a tiny fraction of the apparent violations its staff has identified,” the report said. “Meanwhile, the financial penalties it has imposed pale into insignificance compared to the fines it apparently could have imposed.”
In the 808 cases in which the Big Four performed audits that were so defective that the audit firms should not have vouched for a company’s financial statements, internal controls, or both, only 18 resulted in PCAOB enforcement actions, POGO found.
PCAOB, moreover, could have fined the audit firms more than $1.6 billion but has fined them a total of just $6.5 million, while penalties against individuals at Big Four firms totaled $410,000 — “less money than one partner at a big accounting firm can make in one year.”
According to Reuters, the POGO report “could increase pressure on the [PCAOB], which in recent years has been criticized for being too close to the industry it oversees and slow to ensure the industry performed its job.”
“It’s unacceptable that the agency is taking such a light-handed approach in holding these large audit firms accountable,” POGO’s executive director, Danielle Brian, said in a news release, adding, “By failing to hold the Big Four accountable, the board is putting all Americans’ financial futures in jeopardy.”
The report recommends reforms including requiring the PCAOB to clearly identify companies referenced in inspection reports and the individual auditors responsible for alleged audit deficiencies.
Holding individuals responsible for alleged audit deficiencies is risky business. After all, quite a few auditors review the financial statements, accounting and reporting, and audit report before they are issued. The firms should be held responsible because it’s their job to make sure deficiencies do not exist in audits.
The criticism of the PCAOB boils down to the fact that it does not appear to be making a discernible difference in moving audit firms to reduce audit deficiencies. But the real reason may be the scandal that erupted on January 22, 2018, when a former PCAOB staffer, Brian Sweet, who was hired by KPMG in 2015, leaked confidential information about PCAOB's plans to audit the company. Most of the leaked information concerned which audit engagements the PCAOB planned to inspect, the criteria it was using to select engagements for inspection, and on what these inspections would focus.
The motivation for KPMG in hiring Sweet was the high audit deficiency rate at KPMG when compared to the other Big Four firms. The average audit deficiency rate has ranged between 30-to-40 percent since the program started. The rate for Big-4 firms has gotten as low as 21 percent (Deloitte) and gone as high as 54 percent (KPMG). In the case of KPMG, it was determined that the firm too often failed to gather enough supporting evidence before signing off on a company's financial statements and internal controls.
It is time for Congress to investigate the accounting profession for a lack of independence and high rate of audit deficiencies. These are the two most prominent failures of the PCAOB during its twenty-year tenure. Independence violations are up and the audit deficiency rate, while declining recently, is still too high. In my view, the public is not being protected and we may be just one scandal away from having another meltdown of corporate financial reporting like we saw in 2008-2009.
Posted by Dr. Steven Mintz, The Ethics Sage, on July 15, 2021. You can sign up for his newsletter and learn more about his activities at: https://www.stevenmintzethics.com/. Follow him on Facebook at: https://www.facebook.com/StevenMintzEthics and on Twitter at: https://twitter.com/ethicssage.