Friday, July 01, 2016

PCAOB’s Harris raises alarm about increase in Big Four firms’ consulting and advisory services

By Jacquelyn Lumb

PCAOB member Steve Harris raised alarms about the emerging threat to auditor independence posed by the rise in consulting and advisory services offered by public accounting firms. In remarks to the International Corporate Governance Network, Harris described the growing consulting and advisory services among the Big Four U.S. accounting firms, which he said now dominate the consulting market. This trend is important, he explained, because the last time it occurred was before the SEC’s adoption of new independence rules and the enactment of the Sarbanes-Oxley Act, both in response to accounting firms’ unsuccessful attempts to serve dual roles.

Harris noted that auditor independence violations continue to occur 16 years after the adoption of the SEC’s independence rules. All of the global networks or their affiliates have either settled enforcement actions related to independence violations or have resigned from an engagement because they provided prohibited services, according to Harris. The Board continues to see independence violations and its concerns are shared by its international counterparts, he advised. These continuing violations raise questions about the effectiveness of firms’ controls to prevent the cross-selling and marketing of prohibited services, Harris advised.

Harris characterized the profession’s use of words such as “strategic partners” or “trusted advisers” in describing their relationships with clients as red flags that raise questions about whether the amount or types of services being offered are appropriate for audit clients. Some in the profession are calling for a modernization of the independence rules, he added, which he sees as code for relaxing the independence rules.

The PCAOB is analyzing the business models of auditing firms to determine whether they pose risks to auditor independence and audit quality. Harris said the Board will continue to address its concerns with firm leaders, but also encouraged others to pay close attention to whether the increase in consulting and advisory services may reduce firms’ focus on audit quality and investor protection.

Going concern. Harris reviewed the Board’s initiatives on naming the engagement partners and other participants in an audit and proposed revisions to the auditor’s reporting model, and also discussed going concern. The Board is considering whether revisions are needed to the going concern standard given FASB’s new requirements for management to disclose going concern matters. Harris said that if FASB’s disclosure threshold was applied for the audit, even fewer going concern opinions would be issued than during the past crises.

Harris cited FASB member Lawrence Smith’s dissent when the revisions were adopted, in which Smith said the increased threshold will result in a decrease in the number of going concern disclosures compared to current practice. This is an important transparency issue on which to focus, in his view, and he urged investors to increase their involvement during the Board’s comment process.

Diversity, governance, sustainability. Harris closed with a few thoughts on diversity, audit firm governance, and sustainability reporting. Diverse audit engagement teams result in better audits, he said, just as a diverse board of directors improves shareholder value. He said the profession should be encouraged to continue its efforts to attract and retain talented minorities.

Harris also called on the major accounting firms to increase their board governance diversity by increasing the number of independent individuals who serve on their managing boards. More independent board members will help focus the firms on improving audit quality and preventing potential conflicts, in his view.

With respect to sustainability reporting, Harris said it is currently a voluntary effort in the U.S., other than climate change disclosure, which is required, but is largely presented in a boilerplate manner. He applauded the SEC’s concept release on disclosure reform which includes 11 pages of discussion on sustainability. Harris believes that higher quality disclosure on environmental, social, and governance issues is inevitable, and added that it raises the question of whether it should be subject to independent verification. Sixty-nine percent of the respondents to a CFA Institute survey supported verification measures, he advised.