Friday, December 10, 2010

SEC Senior Official Advises Audit Firms on When to Seek Interim Commission Review of PCAOB Inspection Reports

A senior official in the SEC Office of Chief Accountant has cautioned that nothing about the Commission’s interim review process of the PCAOB’s inspection reports, codified in recently adopted Rule 140, changes the auditor’s responsibility to consider and address all of the Board’s findings in accordance with Board standards. A firm should not use the interim review process as a means to delay consideration of the impact of additional facts or potentially omitted procedures in accordance with AU 390/561, cautioned Senior Associate Chief Accountant John Offenbacher at a recent AICPA seminar.

The SEC staff expects the audit firm to address all matters with the PCAOB before requesting interim review by the Commission. While the official hopes that audit firms and the PCAOB will continue to resolve most matters regarding inspection findings without the need to involve the SEC, Rule 140 does provide a review regime in the limited situations where a firm’s concerns regarding PCAOB findings or determinations cannot be resolved short of SEC review.

Section 104 of Sarbanes-Oxley requires the PCAOB to conduct inspections of audit firms and publish a written report of its findings for each inspection. The firms have an opportunity to review and respond to their draft inspection reports. The portion of the inspection report relating to findings on specific audit engagements, commonly known as Part I of the report, is made public, along with the related response by the firm, upon Board approval of issuance. However, no portions of the inspection report that deal with the firm’s quality controls, commonly known as Part II of the report, are made public if the firm satisfactorily addresses the Board’s criticisms within 12 months of the date of the inspection report.

Adopted to facilitate SEC review, Rule 140 provides that a firm can request interim review by the Commission within 30 days of either the receipt of its final inspection report or within 30 days of receiving notice of an unfavorable determination by the PCAOB regarding remediation of quality control deficiencies. The firm can request interim review with respect to any of the findings in the final inspection report, whether in Part I or Part II, as long as the firm requests that review within 30 days of receiving the final inspection report.

If the firm fails to request review of a specific finding at that time, explained the SEC official, it does not have another opportunity to request review of that finding in that particular inspection report. For example, when a firm requests review of an unfavorable determination by the PCAOB regarding the firm’s remediation of quality control findings, it cannot use that request as an opportunity to request review of any specific findings that it did not previously request the Commission to review. The only thing that can be reviewed at that time is the PCAOB’s unfavorable determination related to the firm’s remediation of Part 2 findings. Thus, Mr. Offenbacher emphasized that the merits of the original quality control criticism or defect cannot be the subject of an interim review request at the time of the request for interim review on the unfavorable remediation determination.

Rule 140 also provides specific direction regarding information that should be submitted to the Commission. Given the staff’s recent experience in performing interim reviews, the senior official advises audit firms considering interim review to spend time with those requirements and to satisfy themselves that they have complied with all aspects of the Rule 140 prior to submitting the request. Under Rule 140, the SEC makes an initial determination as to whether the request should be granted or denied.

The official noted that incomplete requests can hinder the ability to determine whether the review request should be granted. He also reminded auditors of statement in the adopting release indicating that the Commission does not intend to routinely grant review requests absent some indication of concern. In his view, this statement, coupled with the staff’s recent experience in applying Rule 140, reinforces the importance of thorough documentation and complete compliance with the rule.

With regard to requests for interim review of unfavorable determinations on remediation of Part 2 findings, the Senior Associate Chief Accountant advised firms to ensure that they consider the points raised by the PCAOB in the report that the firm receives at the time that they are notified of the unfavorable determination relating to quality control findings. This report is sometimes referred to as a 4009 report, which refers to Board Rule 4009, providing the requirements for addressing firm responses to quality control defects.

The 4009 report provides details regarding the Board’s determination that may be helpful in understanding the Board’s reasoning, said the SEC official, citing recent staff experience showing that sometimes firms simply repeat their original submission to the PCAOB in their request for interim review without addressing the points raised by the Board’s 4009 report to the firm. The official cautioned that such an approach can complicate the analysis as to whether review should be granted because it does not provide a thorough basis to understand why the firm disagrees with the PCAOB.

Rule 140 incorporates an arbitrary and capricious standard of review, observed Mr. Offenbacher, and the SEC believes that this standard creates an incentive for the audit firm to fully address and pursue areas of concern in the inspection report with the PCAOB prior to requesting review by the Commission. For its part, the staff fully expects the firm to address all matters through the PCAOB’s process prior to requesting interim review. The firm should consider fully explaining the process that it undertook with the PCAOB as part of its request for interim review.

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