Yesterday, Caleb shared the details on a tentative new plan hatched by Dodd-Frank that would require nonpublic brokers and dealers to open their doors to that special brand of attention known as PCAOB inspections. We also learned that if the PCAOB gets their way, those special little broker-dealers will be asked to pony up the cash for the privilege of getting PCAOB patdowns.
The Public Company Accounting Oversight Board may require the biggest U.S. broker-dealers to pay more than $1 million a year to fund auditor inspections required under the Dodd-Frank Act.
PCAOB board members voted unanimously Tuesday to seek comment on the proposal, which would create a mechanism for raising the $15 million needed to perform reviews dictated by the financial- regulation overhaul enacted in July.
Unlike audit firms, of which 97% of the littler ones get constantly pestered by the PCAOB while the big boys get their boxes checked and can hit the ranges by noon for cocktail hour on the putting green, the new funding requirement would only affect 14 percent of broker-dealers large enough to meet the PCAOB’s tentative net-capital requirements.
These fees would account for seven percent of the PCAOB’s total funding, guesstimated terminally-acting PCAOB chair Dan Goelzer.
PCAOB board member Bill Gradison is sure that the PCAOB is serious about identifying issues and doing its job protecting the public or whatever the hell it is they are there to do. That means no working things out as they go, I suppose. He swears the interim inspection program is not “just a learning experience for the PCAOB” and “could have consequences for the firms involved.” That’s if anyone finds anything fishy, I am guessing.
Prior to Dodd-Frank, auditors who inspected the books of nonpublic brokers and dealers were required to register with the PCAOB but managed to avoid being subjected to the Board Insepctors’ Monday Morning QBing. Now that we’ve entered a new, exciting era of mind-numbingly complex financial regulation, auditors of all broker-dealers will soon know the pleasure of the PCAOB inspection process.
But before any of you get your knickers in a twist, it’s technically an “Interim Program,” because, in all honesty, the Board isn’t exactly sure who should be getting extra-special attention and who they can ignore.
This is part of the statement from Perpetual-acting Chair Dan Goel ://pcaobus.org/News/Releases/Pages/12092010_OpenBoardMeeting.aspx”>today’s open meeting (full statement on following slide):
About 520 brokerage firms provide clearing or custodial services. Many of the others are introducing firms that, at least in theory, do not have access to client funds or securities. Some are floor brokers without public clients; some are insurance agents that sell products that are technically securities; some are finders active in the M&A market; some are captives that serve the trading needs of a single, affiliated client. Other categories undoubtedly exist. This diversity raises questions about whether we should devote resources to inspecting the auditors of all of these types of brokers and dealers or whether some of their auditors can safely be exempted from PCAOB oversight without compromising investor protection.
While the Board does not yet have the answers to those questions, the temporary rule will allow the Board to begin inspections of broker-dealer audits so that we can develop an empirical basis on which to eventually address them.
So, in other words, the Board has NFI where to start since the broker-dealer biz encapsulates a lot of different services. The unfortunate thing for auditors is that the inspectors have to start somewhere and that’s what this interim program will do. Mr Goelzer gives you a taste of the fun to come:
The interim inspections will focus both on reviewing the work performed on specific audits and on gathering facts to inform the Board’s consideration of a permanent program. The information-gathering aspect of the interim inspections will provide the Board with insight about the potential benefits of broker-dealer inspections to the investing public and about the potential costs and regulatory burdens that would be imposed on different categories of accounting firms and classes of brokers. Armed with this type of information, the Board will be in a better position to decide on possible exemptions from oversight and to determine the objectives, nature, and frequency of inspections for firms that remain subject to PCAOB jurisdiction.
So if you’re lucky, you might – just might! – get out of the whole process altogether, although, we suggest you don’t get your hopes up. When will this all get sorted out, you ask?
Decisions about the permanent inspection program are probably at least a year away. In the mean-time, there will be ample opportunity for the public to learn what the Board is finding in the interim program and to participate in the decision process.
The proposed temporary rule provides for transparency, in that the Board will issue public reports at least annually on the progress of the interim program and on any significant observations. The permanent broker-dealer auditor inspection program will be predicated on rules that will only be adopted by the Board after public notice-and-comment and will only take effect after Securities and Exchange Commission approval.
So if this whole thing sounds like a dry run, it is. However if inspectors stumble across some über-shoddy audits (bound to happen), the Board is reserving the right to lay the smackdown. From Board Member Steven Harris’s statement (full text on last slide), “While the temporary inspection rules anticipate that firm-specific inspection reports would not begin until after a permanent program takes effect, it is important to note that the Board will still take disciplinary action, as appropriate, against an auditor where inspections under the interim program have identified significant issues in the firm’s audit work.” Likewise, if the inspectors happen across out of the ordinary at the B-D (again, a distinct possibility), they will be ringing up the SEC.
So while on the one hand they’re testing the waters, if you happen to be a downright horrible auditing firm, they’re going to make an example out of you. Investor protection is still at stake, you know.
Just a brief follow-up on the manager who received the disciplinary action handed down by the PCAOB on Monday.
We attempted to reach Jacqueline Higgins late yesterday at her office number in Boston, however we discovered that when we were transferred to her extension we simply bounced back to reception, who needless to say, was very confused about that phenomenon. After attempting to page Ms. Higgins, only then did the receptionist learn and then relay to us that Ms. Higgins was no longer with the firm.
We checked with Ernst & Young spokesman Charlie Perkins on this development and he confirmed that Ms. Higgins “will be leaving the firm at the end of the year.”
And lest there still be any confusion due to the carefully worded E&Y statement, the partner and senior manager in question have been dismissed from the firm.
We’ll keep you updated if we hear more from inside at the firm or if further action is taken by the PCAOB.
Part of perpetually-acting PCAOB chairman Dan Goelzer’s speech at the AICPA’s Conference on SEC and PCAOB Developments had to do with the future and it kinda, sorta sounds like the Board might start asking for more than just the auditor’s opinion of yore. He spoke this afternoon at the conference, saying, “it is clear that there is considerable investor hunger for more insight from the auditor into the audit process and the company’s financial reporting. Further, the 2008 report of the Treasury Advisory Committee on the Auditing Profession recommended that the Board reconsider the audit report.”
What kind of ideas? Glad you asked!
The Board will have to make some difficult choices next year if it decides to change the time-honored pass/fail report. There is no shortage of ideas. During a discussion of the reporting model at our Standing Advisory Group meeting last April, some suggested that the auditor should provide more information about the audit itself and how it was performed. Others want the auditor’s views on the management judgments embodied in the financial statements regarding such things as estimates and the selection of accounting policies. Auditors have proposed that their reports should be clearer about limitations on the ability to detect fraud. Some users have suggested expanding the auditor’s current opinion to include new material; others have suggested that the pass/fail report should be accompanied by a separate auditor’s report akin to the MD&A.
Do investors really want to know how the audit sausage is made? Some auditors have trouble pulling things together so we see little up side there.
If you’ve got your own suggestions on making audits even better, feel free to share them at this time.
~Update 2 includes statement from Claudius Modesti, PCAOB Director of Enforcement and Investigations
Today in obscure accounting oversight board enforcement actions, an Ernst & Young Manager in the Boston office was censured by the PCAOB for repeated violations o y to Cooperate with Inspectors, and Auditing Standard No. 3 (“AS3”), Audit Documentation.
The violations occurred when 27 year-old Jacqueline Higgins “(1) added documents to the working papers without indicating the dates that documents were added to the working papers, the names of the persons preparing the additional documentation, and the reason for adding the documentation months after the documentation completion date; and (2) removed a document from the working
papers after the documentation completion date.”
The timeline goes like this: E&Y was given notice by the PCAOB that an inspection of the unknown company’s audit was being performed on March 30, 2010 and the partner, senior manager and manager on the engagement were given notice on March 31, 2010. The inspection fieldwork was set to begin on April 19, 2010.
On April 5th, the three Ernsters began preparing for the inspection and that’s when problems started cropping up which led to more trouble. The order has the details:
First, Respondent reported to the Engagement Partner and the Senior Manager that a “Review Procedures Memorandum” was missing from the external working papers. The Engagement Partner and the Senior Manager directed Respondent to create and print out the missing document, and to backdate the document to November 30, 2009. The Engagement Partner and the Senior Manager directed Respondent to backdate her sign-off on this working paper to November 30, 2009, and to add this document to the external working papers.
17. Second, Respondent reported to the Engagement Partner that the tie-out of the financial statements contained in the external working papers was performed upon a pre-final set of financial statements. The Engagement Partner directed Respondent to remove this document from the external working papers, and to replace it with a newly created document which tied-out the final financial statements, and which the Engagement Partner directed Respondent to backdate to November 2009.
18. Third, Respondent reported to the Engagement Partner that the Average Forward Foreign Currency Contracts Calculation (“A3a Working Paper”) was missing from the external working papers. The Engagement Partner directed Respondent to gather the missing document, backdate it to November 2009, and add it to the external working papers.
19. Finally, Respondent reported to the Senior Manager that three checklists were missing from the external working papers. The Senior Manager directed Respondent to assemble the missing checklists as a single document (“HH6.8 Working Paper”) and to backdate her sign-off on this working paper to November 2009. The Senior Manager directed Respondent to add the document to the external working papers. The Senior Manager and Respondent reported to the Engagement Partner the facts and circumstances related to the creation of the HH6.8 Working Paper, and the Engagement Partner took no steps to cause the document to be properly dated, or to have it removed from the external working papers.
So those are the wonky details. Where this particular story is most interesting (in our opinion) is that Ms Higgins was, prior to this little mishap, on the fast track. According to the order, she graduated in May of 2005 and started with E&Y in September. She was promoted to senior associate in October of 2007 and then promoted to manager in October of 2009. Now, perhaps she was an audit-savant or perhaps not but in just over four years, she was a manager, which is a much quicker pace than usual.
Granted, she was still under the supervision of the senior manager and partner on the engagement but a young manager nevertheless. Now, you might be asking yourself, “what about the senior manager and partner? Are they getting their wrists slapped?” Conventional wisdom tell us, “absofuckinglutely” but the PCAOB isn’t saying. We were told by a spokesperson that the Board cannot comment on any other action related to this case.
As far as what a censure by the PCAOB actually entails, we were told that “It is an official reprimand from the PCAOB.” Some might call it a wrist slap but we’re damn sure you don’t want that in your file when you’re 27 years old. The action also states that Ms. Higgins was removed from the engagement in July 2010 and “at that time Higgins ceased participating in issuer audit engagements.”
Messages with E&Y spokesperson Charles Perkins and A message left with an attorney for Ms. Higgins were not immediately returned.
Ernst & Young has issued the following statement:
Our firm policy clearly prohibits persons from supplementing audit workpapers in circumstances like those described in the disciplinary order. When we determined that firm policy had been violated, we put the three individuals involved on administrative leave and subsequently separated the partner and senior manager. We have advised the PCAOB of these facts and have cooperated fully with the PCAOB throughout its investigation of this matter.
Based on the above, you might conclude that more disciplinary action will be coming from the PCAOB but like we said, they’re not talking.
UPDATE 2 – circa 3:30 pm: Claudius Modesti, PCAOB Director of Enforcement and Investigations, explained the seemingly light punishment in an email to Going Concern:
As to the censure, under the facts and circumstances, the censure is appropriate given Higgins’ relatively junior position on the audit team and her overall role in the conduct. We also considered the fact that she settled the matter without requiring the Board to commence litigation, which would have been nonpublic as required by the Sarbanes-Oxley Act.”
It was then explained to us that the PCAOB has never explained a disciplinary action in this way: “We also considered the fact that she settled the matter without requiring the Board to commence litigation, which would have been nonpublic as required by the Sarbanes-Oxley Act.”
If that’s not quite clear, consider this: It is significant because, had Ms Higgins acted in the alternative (i.e. not settled), litigation would have been necessary and no one outside of the PCAOB, Higgins, her lawyers and E&Y would have known about the proceedings. Granted, it’s fairly common for lighter disciplinary action to result from a settlement but it also makes sense from a PR perspective (not to mention, transparency and investor protection) if the PCAOB can actually announce that they are taking action against people who break the rules. Part of the challenge the Board has faced is convincing anyone that they have teeth.
It will be interesting now to see if the senior manager and partner follow the same track as Ms. Higgins and how the PCAOB will respond to their cooperation (or lack thereof).
The PCAOB managed to roll out some news at a time other than 4 pm on Friday, announcing new appointments and reappointments to their Standing Advisory Group.
All the major firms are represented as well as some regionals (BKD, EKS&H), academics, industry pros, and others. We haven’t had the pleasure of knowing any of these fine folks (minus Lynn Turner – probably the biggest pot-stirrer on the list) but we’ve got it on good authority that everyone can get audit wonky (e.g. broker dealer auditing, the audit report model, FASB changes affecting auditing). The ushe. So you can rest soundly knowing your audit rules are in good hands.
Standing rs
New Appointments
• Stephen J. Homza, Managing Director of Internal Audit, Legg Mason, Inc.
• Lisa Lindsley, Director of Capital Strategies, American Federation of State, County, and Municipal Employees
• William T. Platt, Deputy Managing Partner, Professional Practice, and Deputy Chief Quality Officer – Attest, Deloitte & Touche, LLP
• D. Scott Showalter, Professor of Practice, Department of Accounting, College of Management, North Carolina State University
•Dan M. Slack, Chief Executive Officer, Fire and Police Pension Association of Colorado
Reappointments
• Joseph V. Carcello, Ernst & Young and Business Alumni Professor, Department of Accounting and Information Management, and Co-Founder and Director of Research, Corporate Governance Center, University of Tennessee
• James D. Cox, Brainerd Currie Professor of Law, School of Law, Duke University
• Elizabeth S. Gantnier, Director of Quality Control, Stegman & Company
• Arnold C. Hanish, Vice President of Finance, Chief Accounting Officer, Eli Lilly & Company
• Gail L. Hanson, Deputy Executive Director, State of Wisconsin Investment Board
• Jamie S. Miller, Vice President, Controller and Chief Accounting Officer, General Electric Company
• Steven B. Rafferty, Professional Practices Partner, BKD, LLP
•Samuel J. Ranzilla, Audit Partner and National Managing Partner, Audit Quality and Professional Practice, KPMG LLP
• Lynn E. Turner, Senior Advisor and Managing Director, LECG
Continuing Members
• John L. (Arch) Archambault, Senior Partner, Professional Standards and Global Public Policy, Grant Thornton LLP
• Dennis R. Beresford, Ernst & Young Executive Professor of Accounting, Terry College of Business, The University of Georgia
• Neri Bukspan, Executive Managing Director, Chief Quality Officer, and Chief Accountant, Credit Market Services, Standard & Poor’s Financial Services, LLC
• Douglas R. Carmichael, Claire and Eli Mason Professor of Accountancy, Zicklin School of Business, Baruch College
• Margaret M. Foran, Chief Governance Officer, Vice President, and Corporate Secretary, Prudential Financial, Inc.
• Michael J. Gallagher, Assurance Partner and U.S. Assurance National Office Leader, PwC
• Gaylen R. Hansen, Audit Partner and Director of Accounting and Auditing Quality Assurance, Ehrhardt Keefe Steiner & Hottman PC
•Patricia Ann K. (Kiko) Harvey, Vice President, Corporate Audit and Enterprise Risk Management, Delta Air Lines
•Gary R. Kabureck, Vice President and Chief Accounting Officer, Xerox Corporation
•Anthony S. Kendall, Chief Executive Officer, Mitchell & Titus LLP
•Wayne A. Kolins, Partner and National Director of Assurance, BDO USA, LLP; Global Head of Audit and Accounting, BDO International Limited
•Jeffrey P. Mahoney, General Counsel, Council of Institutional Investors
•Mary Hartman Morris, Investment Officer, Global Equity, California Public Employees’ Retirement System
•Kevin B. Reilly, Americas Vice Chair, Professional Practice and Risk Management, Ernst & Young LLP
•Barbara L. Roper, Director of Investor Protection, Consumer Federation of America
•Lawrence J. Salva, Senior Vice President, Chief Accounting Officer and Controller, Comcast Corporation
•Kurt N. Schacht, Managing Director, CFA Institute
•Damon A. Silvers, Director of Policy and Special Counsel, AFL-CIO
•John W. White, Partner, Corporate Department, Cravath, Swaine & Moore LLP
The long-awaited PCAOB inspection report of KPMG came out on Friday and while we were excited for this unveiling, the Board managed to issue the report at around 4 pm on Friday. Since the Board lacks any sense of timing whatsoever, we opted to punt on our respective post until today because well, we’re human and not a soulless blogging robot as likely perceived by TPTB at the PCAOB.
It’s worth mentioning that this is the first PCAOB report that has been issued since the SEC’s final rule on the inspections that allows audit firms to postpone the release of the report simply by taking issue with any of the findings. Since any appeal could reportedly delay the report by “30 to 100 days,” it’s safe to assume that, with a report date of October 5th, KPMG didn’t have a beef with the findings. You could also assume that since the SEC is taking a peek at these reports now, there’s going to be a ten day lag on the release of the report to allow the Commission enough time to give it their extra-special sniff test.
Anyway, back to the matter at hand –
KPMG had eight issuers noted in the Board’s inspection report and the first two are doozies. “Issuer A” runs approximately two pages and includes failure on testing of “allowance for loan losses” to “test[ing] the issuer’s estimates of fair values of financial instruments” and goodwill impairment.
“Issuer B” is a little more interesting since one of the failures the Board found was related to deferred tax assets which makes us wonder if this is Citi, since analyst Mike Mayo was loudly questioning the bank’s treatment of its DTA. Francine McKenna not-so-subtly solicited guesses on Friday as to who this “bank” might be (even though no issuer is identified as such) but it does make us wonder.
The Board cites run-of-the-mill failures for the rest of the issuers (e.g. fair value testing, pension plan testing, failure to confirm cash[!]) and the House of Klynveld’s response letter was cordial and anticlimactic.
But if you’re KPMG, do you really care what the PCAOB thinks when you’ve got an adorable gnome-ish looking analyst giving you the tepid thumbs-up (despite not knowing your name)? That’s the only endorsement we would need.
Why? Apparently because they just considered the needs of auditors. Audit committee members were feeling left out (and are, presumably, just as uncomfortable conversing with humans as auditors) so it’s back to the drawing board:
At a July 15 meeting of the PCAOB’s Standing Advisory Group, Goelzer said comments reflected a wide range of views. “A number of comments suggested that we needed to do more homework, more outreach on this subject,” he said. “Some thought we approached the subject too much from the perspective of the auditor and without a full appreciation of what audit committee members wanted or needed.”
A briefing paper to set the stage for the Sept. 21 roundtable says the board is holding the roundtable to get more insight from investors, audit committee members, auditors, and management on the proposed standard. The briefing paper outlines a number of questions the board wants to explore focused primary on what information is most relevant to audit committees, and how auditors and audit committees should communicate on those issues.
Despite the setback that was the creation of the PCAOB, the Big 4 have to be pret-tay, pret-tay, pret-tay pleased with the privacy they get when it comes to the Board’s disciplinary actions.
Perpetually-acting chair Dan Goelzer wrote a letter to the Senate Banking and House Financial Services Committees saying that by keeping the proceedings mysterio and out of the public eye. The current arrangement “gives firms and auditors an incentive to drag out litigation, sometimes for years,” and that simply won’t do.
Despite the general public’s disinterest in all things accounting (until the shit hits the fan, of course), the Board is still trying to find its place as the relatively new kid on the bureaucratic block. This request seems to be an attempt at fitting in:
The Public Company Accounting Oversight Board’s proposal would repeal a requirement that its disciplinary actions remain secret, according to a copy of the document reviewed by Dow Jones.
The public now is denied access to information about accountants that have been sanctioned or charged by the PCAOB, acting Chairman Daniel Goelzer said in an Aug. 24 letter to several members of the Senate Banking Committee and House Financial Services Committee.
Since the federal government has been all about transparency lately, it would be surprising for Congress to take the Board up on the offer. The problem is, it won’t really do much to speed anything along and transparency will remain an issue. If you remember, last month the SEC issued its final rule on the PCAOB appeals process that goes into effect next week.
That rule will: allow firms to dispute findings during the inspection process; prohibit the PCAOB from making those disputed findings public until the SEC investigation is completed and the SEC still has the option to make findings permanently private, if it so chooses.
So even if Congress is convinced that the PCAOB’s plan to make the proceedings public is utter genius , accounting firms will still be able to drag things along (and keep things secret) as they see fit.
The PCAOB has had a pretty good run of late. It all started with the SCOTUS handing them a loss that was really a win and the Board has, most recently, gotten ambitious with new risk assessment standards. What’s more is the call of acting Chair Dan Goelzer to have the Board’s enforcement inspections held publicly so audit firms can’t get all mysterio about what they did and did not do to warrant said inspection.
Well, the run of luck appears to have come to an end as the SEC issued a new rule that takes effect next month that marginalizes the Board to the benefit of the accounting firms it oversees (our emphasis).
Going into effect September 7, the rule explains how accounting firms can dispute the PCAOB’s findings during its inspection process. The firms have always had this ability under the Sarbanes-Oxley Act, but the SEC lacked a formal appeals process. (Indeed, the June 28 Supreme Court decision, which affirmed the constitutionality of the PCAOB, arose out of a small accounting firm’s dissatisfaction with its 2004 inspection report.)
A key feature of the process is secrecy. If an accounting firm appeals to the SEC, the PCAOB will be prohibited from making disputed portions of its inspection report public until the commission completes its review, which could take anywhere from 30 days to over 100 days. Moreover, the SEC could decide to keep the information permanently private if its reviewers determine that the PCAOB’s findings were “arbitrary and capricious.”
Meanwhile, the public will learn nothing about the appeals process or the issues under contention, which will further cloud the results of PCAOB inspections for the accounting firms’ corporate clients who read them. “Until now, the SEC has not restricted the transparency of inspection reports pending the opportunity to seek review,” a PCAOB spokesman tells CFO.
So let’s get this straight – if an accounting firm takes issue with anything in the PCAOB’s report, the firm can then run crying to the SEC – which makes that portion of the report secret – and then the report will sit dormant until that portion reads to their liking which can take 30 to 100 days? OH! And on top of that, if the SEC finds something to be ‘arbitrary and capricious’ that issue will never see the light of day?
It’s not like these inspection reports are being issued at a rapid clip (PwC’s and KPMG’s reports for ’09 are still MIA) or filled with details that are actually meaningful to regular folks (e.g. the clients inspected) and now the SEC is going to let the firms write their own inspection reports.
So much for that small matter of “Oversight.” At least the SEC is being (somewhat) transparent about a power grab.
