Monday, May 23, 2011

PCAOB Member Hanson Says Transparency Is Central to the Board’s Mission

Transparency is at the heart of some of the standards and other projects that the PCAOB is working on in the near term, said PCAOB Member Jay Hanson. In that spirit, he noted that the Board is preparing a concept release to seek public comment on possible changes to the auditor's reporting model with the intention of increasing its transparency and relevance, while not compromising audit quality. In recent remarks, he said that determining how to go about this involves some difficult issues, including balancing the benefits of those potential changes to investors with the potential costs of those changes to the companies and their auditors. In considering these questions, the Board is very interested in the views of management of the companies whose audits will be affected.

These remarks come against the backdrop of recent questioning of the relevance of the outside auditor report on a company’s financial statements, which some commenters have described as a binary boilerplate document with little relevant information for investors and other users of the financial statements. There is a growing consensus that the status quo on audit reports is no longer either appropriate or sustainable.

Board Member Hanson compared a company’s financial statements and annual report to a book report, with many thousands or millions of transactions in a given area summarized into accounts that appear in the financial statements. The footnotes describe some of the accounting policies and details behind the numbers. Management's discussion and analysis explains the numbers and the trends. The financial statements and annual report are sometimes hundreds of pages long, he noted, making for a long and complicated book report.

The auditors carefully review all of this information, conduct certain procedures to test some of the information and underlying assumptions, evaluate the company’s accounting decisions, and issue a report stating simply that the numbers in the financial statements are, or are not, presented fairly in accordance with the relevant accounting standards. The PCAOB has heard that investors are asking for more than this from auditors, and, to some degree, management. This was the conclusion of a report delivered at a recent meeting by a working group of the PCAOB’s Investor Advisory Group. The report found that investors want more information on, among other things, risks, unusual transactions, and the company’s accounting policies. In essence, said Member Hanson, investors want auditors to provide an executive summary of the book report, with further discussion around the question, "How good are the numbers?"

On another area of transparency, Member Hanson said that the Board is deliberating on whether to call on auditors to disclose the location of other firms participating in the audit, which the Board Member called a ``critical piece of information’’, and on which disclosure should come from a variety of angles. This disclosure is important, he explained, because many multi-national companies conduct a significant portion of the audit abroad. While the audit report may be signed by a U.S. auditing firm, he observed, it may be largely based on the work of affiliated firms that are completely separate legal entities in other countries.

More broadly, the Board is concerned about the number of those countries that prohibit the PCAOB from inspecting accounting firms based in their jurisdictions. Until recently, the Board was completely blocked out of the European Union. In January, the Board reached an agreement to conduct inspections in the United Kingdom, and is working with other EU countries on similar agreements. But the Board continues to be blocked from performing inspections of accounting firms in China.

Member Hanson emphasized that the Board is trying hard to ensure that it reach agreements with regulators in those countries to inspect the work of the auditors. In the meantime, the Board believes that more transparency from auditors about what affiliates in what countries were used for the audit, along with an indication of the significance of the work done, will give public companies and investors better information about the degree of PCAOB oversight of the respective firms and audits

Enforcement actions is another area in which the PCAOB is seeking to increase transparency. Currently, the Sarbanes-Oxley Act requires that the Board keep confidential any disciplinary proceedings initiated against CPA firms or individual auditors until those matters have been resolved at the Board level and the respondent firm or auditor has had an opportunity to appeal the Board’s decision to the SEC. This is unlike the practice at the SEC, where enforcement actions against accountants are visible to the public long before they are adjudicated or settled.

The Board has urged Congress to consider changing that. Member Hanson described the road to the enactment of legislation in this area as long and controversial. But the Board will persevere in this goal because, according to Member Hanson, if there is an auditor who the Board thinks is just not doing a good job and not serving investors, it is important that investors have knowledge of the enforcement proceedings against that auditor long before the current rules allow the Board to disclose that information.