Thursday, October 14, 2010

Former SEC Chair Rod Hills Asks Commission to Create Safe Harbor for Auditor Professional Judgments

Former SEC Chair Rod Hills and Deloitte Deputy CEO Robert Kueppers said that there has been a significant increase in the intrinsic value of the outside, independent audit of corporate financial statements since the Sarbanes-Oxley Act created the PCAOB audit inspection regime. In remarks at a fireside chat hosted by the SEC Historical Society, they also see a beneficial enhancement of the audit committee’s role in taking charge of the outside audit process in the post-Sarbanes-Oxley era. With the advent of principles-based accounting and auditing standards, former Chairman Hills also urged the SEC to create a safe harbor for an auditor’s professional judgment. He emphasized that a plaintiff should not have the right to question an auditor’s professional judgment if the SEC and the PCAOB are happy with that judgment.

Mr. Kueppers, who was an SEC Professional Accounting Fellow, said that the PCAOB has had a dramatic impact on how auditors perform and indeed on the entire audit process. Previous to the Board and Section 404 of Sarbanes-Oxley, he noted, companies had lost their focus on internal controls and had largely deferred required maintenance on their internal controls. Section 404 was a game changer in the way that audits are executed. With the refocus on internal controls, he added, company restatements of their financials are ``dropping like a rock.’’ Overall, the quality of audits are better because of the Board and the Sarbanes-Oxley regime. He cited a recent survey of audit committees that overwhelming concluded that financial statement audits are better today than before the passage of Sarbanes-Oxley.

According to former Chairman Hills, another beneficial effect of Sarbanes-Oxley is that audit committees have taken charge of the outside audit process. The audit committee now interviews and hires the audit firm, sets the scope of the audit, and sets the auditor’s fee. Another beneficial change is that the board nominating committee selects new candidates for the audit committee and management is not part of that process, which means that audit committee members owe nothing to company management. Mr. Kueppers noted that, with the five-year audit partner rotation regime now in place, the audit committee takes full charge and interviews partners in order to match a partner’s skills with the company’s requirements.

Globalization presents a set of very difficult challenges, they agreed, because, according to Mr. Kueppers, it is a fair accompli that, outside the US, IFRS is the accounting standard regime used by all the major economies. There is a danger that the Board could have one set of requirements while its global regulatory counterparts will have another. Since we are not likely to have a global audit regulator any time soon, he added, consistency of audit standards and collaboration on common agendas will be needed.

Another difference is that IFRS are principles-based, and with principles-based standards the professional judgment of accountants and auditors becomes more important. In the view of former SEC Chair Hills, at the end of the principles-based day the US will still have a litigation environment under which US auditors could be sued for a professional judgment that a European auditor could make with impunity. As we move towards principles-based audit and accounting standards, Mr. Hills urged the SEC to create a safe harbor for auditor professional judgments.