Tuesday, November 22, 2011

Bi-Partisan Senate Legislation Would Enhance Transparency of PCAOB Proceedings

Senators Jack Reed (D-RI) and Charles Grassley (R-Iowa) have introduced legislation making PCAOB disciplinary proceedings public to bring auditing deficiencies at the audit firms or the companies they audit to light in a timely manner and help deter violations. The PCAOB Enforcement Transparency Act, S 1907, would make hearings by the PCAOB, and all related notices, orders, and motions, open and available to the public unless otherwise ordered by the Board. The Board procedure would then be similar to the SEC's Rules of Practice for similar matters, where hearings and related notices, orders, and motions are open and available to the public.

The PCAOB is responsible for setting auditing standards for auditors of public companies, for examining the quality of audits performed by public company auditors, and where necessary, for imposing disciplinary sanctions on registered auditors and auditing firms. The Board's ability to commence proceedings to determine whether there have been violations of its auditing standards or rules of professional practice is an important component of its oversight.

In order to determine whether to institute a proceeding, the Board's enforcement staff conducts a nonpublic investigation and makes a recommendation to the five-member Board. However, unlike other oversight bodies, such as the SEC and the CFTC, the Board's disciplinary proceedings are not allowed to be public.

Unfortunately, noted Senator Reed, over the last several years, bad actors have been taking advantage of this lack of transparency. In April 2011, the Senate Securities Subcommittee, which he chairs, considered the issue of enhancing the PCAOB's effectiveness by permitting the Board to disclose information about its enforcement proceedings. PCAOB Chair James Doty noted that the secrecy has a variety of unfortunate consequences and this state of affairs is not good for investors, for the auditing profession, or for the public at large. Cong. Record, Nov. 18, 2011, pp. S 7831-7832.

In one example cited by Senator Reed, an accounting firm that was subject to a disciplinary proceeding continued to issue no fewer than 29 additional audit reports on public companies without any of those companies knowing about the PCAOB proceedings. Those public companies and their investors were completely in the dark about the board's decision to both institute disciplinary proceedings and about the progress of those proceedings. The auditor knew about the proceedings, but the investors and public companies were denied information that was arguably very relevant to the audit relationship. Cong. Record, Nov. 18, 2011, pp. S 7831-7832.

Senator Reed noted three additional reasons that the proceedings should be open and transparent. First, the closed proceedings run counter to the public proceedings of other oversight bodies. Nearly all administrative proceedings brought by the SEC against public companies, brokers, dealers, investment advisers, and others are open, public proceedings. Cong. Record, Nov. 18, 2011, pp. S 7831-7832.

The PCAOB's secret proceedings are not only shielded from the public, said Senator Reed, but from Congress as well. The public and Congress have a role in ensuring that not just auditors are held to account, he emphasized, but also that the PCAOB is held to account as well for its oversight of the auditors and audit firms.

Second, the incentive to litigate cases in order to continue to shield conduct from the public as long as possible frustrates the process and requires the expenditure of needless resources by both litigants and the PCAOB. In April, Chairman Doty, in testimony before the Securities Subcommittee, noted that the fact that PCAOB disciplinary proceedings are required to be secret creates a considerable incentive to litigate.

Third, a recent academic study noted that the public nature of SEC proceedings against companies creates good results. The study observed that a public SEC enforcement action in its industry against a target firm is likely to increase a peer firm's knowledge about SEC activity and cause it to revise upward its subjective probability of attracting such an action against itself. In effect, the study noted that this may serve as a deterrent to misconduct because of a perceived increase in getting caught. Accordingly, the audit industry would also benefit from timely, public, and non-secret enforcement proceedings.

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