Please ensure Javascript is enabled for purposes of website accessibility

Here’s Why Releasing Part II of the PCAOB Inspection Reports Is Important

I know what a lot of you are thinking — "The PCOAB is a bunch of couldn't-hack-it-in-public know-nothings that like nothing more than making hard-working auditors' lives a living hell. And, oh, Part II doesn't mean jack squat." FANTASTIC! Then you won't mind that I'm going to spend the next few hundred words telling you why you're wrong. Wrong. WRONG!

But first, it may be useful to outline the feelings of those that believe Part II — and the PCAOB at large — is tens pounds of monkey crap stuffed into a five pound bag.

To kick things off, here's an anecdote that we received yesterday after our post on supervision was published:

My company is audited by [well-known public accounting firm]. Despite their own issues with the PCAOB, the bullshit continues. For the entire first week of year-end fieldwork, they had a new staff (3-4 months out of college) out here by herself auditing a variety of different areas. No (physical) supervision whatsoever. The people in our acctg department were just answering her questions and I'm pretty sure she had no idea what they were talking about. I brought this to my CFO's attention just to see what his response would be. He laughed and said it was wrong, but basically he doesn't give a shit. As long as [well-known public accounting firm] signs off by the deadline. [T]he talk from [the public accounting firms] about how serious they take the PCAOB inspection findings is just lip service.

Okay, admittedly, that doesn't sound so great. As for the anti-Part II talking points, here are the talking points:

  • The issuers are not named.
  • The partners in charge of the engagements with deficiencies are not named.
  • There are no civil penalties or other measurable form of punishment for audit firms that don't comply.
  • The process is too long. "Oh, the faceless partner on an unnamed audit client from four years ago didn't properly supervise the engagement? That's dynamite, guys."
  • The PCAOB doesn't analyze the year-to-year improvements (or lack thereof) for each firm nor does it put the inspection reports in context by comparing them to peer firms. All it does is report findings.

And you know what? I agree with all of these! The whole process seems pretty harmless — investors don't get bent out of shape; the partners aren't held responsible, at least not publicly; even if there were civil penalties they are largely pointless since the firms have plenty of money for a rainy day1; the information isn't timely, and finally, the Board doesn't use all this valuable data to tell us much other than which firms suck the worst. And even that isn't clear because of the nature of the audits for each firm are different. 

Pretty compelling case for Part II suckitude, isn't it? Wouldn't it be nice if the PCAOB could actually do something about these things2?

Luckily, the issuance of Part II does manage to accomplish one very important thing: it's an official branding — a Scarlet Letter, Mark of the Beast, whatever you like — that has a lasting effect on the audit firm's reputation until the firm takes the necessary action to patch up its reputation3

See, it goes like this — once upon a time, enterprising young number crunchers wanted to provide assurance services. Why? Well, there were some businesses who did some bad things with their numbers and lots of people lost lots of money. It was decided that some compliance was in order so that these bad things wouldn't happen again. This required professional service firms staffed with men (sorry ladies, it was the 19th Century) of the highest integrity; men who could be trusted to call a spade and spade and a fraud a fraud. Who were these men, exactly? Well, their names (or initials) are now on the poorly-made polo shirts that you wear on hot summer days. Names that appear on the wall of the building where you work. Sure, these guys might have been egomaniacal, shrewd businessmen, but they believed that their integrity and reputations as egomaniacal, shrewd businessmen meant everything because they had the duty to protect the money of the investors whose money was at risk. That really meant something to them. I know, you don't get it. They had beards and used pocket watches and wore funny hats. A different very time…wait, never mind. 

Anyway. Like every seemingly decent idea, from Joey to Dippin' Dots, it was doomed to failure4. These days, firms trade their wares on the principles that were built long ago by guys whose brains would explode if they read today's accounting rules and who would mumble to themselves when they learned that a government — GOVERNMENT! — regulator was needed to watch the watchmen. Shameful!

But that's where we stand today. A government regulator that largely has its hands tied. BUT! Part IIs should prod audit committees into asking their auditors some awkward questions. Questions like, "Hey, isn't that kind of a big deal?" or "Did our audit have any deficiencies?" or "Can you recommend a firm that didn't have such a high error rate?" or "Whose supervising all those kids?"

Andersen didn't go down for the dirt nap because they paid a gajillion dollar fine or lost a big lawsuit. They failed because they lost the trust of everyone. EVERYONE. And trust was something the old man spent his whole life building and the firm used as a marketing ploy and bargaining chip right up until the point when clients started saying, "How can you live with yourselves?" We probably won't see another spectacular failure like that coming until it's too late (the PCAOB isn't meant to prevent spectacular failures anyway) but in the meantime, "trust" is more of a punchline than ever when put in the context of audit firms. The Part IIs have helped expose that joke. 

Sure, maybe PwC and Deloitte probably haven't lost the trust of everyone, and maybe they don't care; but then the names on the signs mean less than they ever did. Or maybe they don't mean anything at all.

1 But do they really? We can't possibly know, thanks to the non-existent financial reporting. That's a discussion for another day.
2 Here's their agenda for 2013. So far, engagement partner transparency is only one that's on the table.
3 And, by most accounts, Deloitte's reputation is not good right now. PwC shouldn't expect any different. Good times!
4 Although Dippin' Dots really hasn't failed. Somehow the Ice Cream of the Future lives on in ballparks around the country to my complete bewilderment. Who is behind their continued existence? You can't simply call yourself the Ice Cream of the Future and continue on into the future. WE'RE IN THE FUTURE NOW. What kind of power do the Dippin' Dots people have that allows them to continue on?