Tuesday, December 13, 2016

PCAOB officials provide inspections, enforcement updates

By Amanda Maine, J.D.

Helen Munter, director of the PCAOB’s Division of Registration and Inspections, and Claudius Modesti, director of Enforcement, outlined the recent activities of their respective divisions at the AICPA’s recent conference on SEC and PCAOB developments.

Inspections. The Board’s recent inspections have revealed that findings continue to exist in spite of remedial actions taken by firms, Munter said. She advised that inspections staff is incorporating randomization into the Division’s risk-based approach to inspections. By doing this, the Division hopes to say something about the state of audit quality and where it is trending.

Munter also said that the staff will continue to make use of analytics and technology, an opportunity the Division intends to scope out in more depth in 2017.

Regarding the results of the 2016 inspections cycle so far, Munter reported that for some firms, the staff has observed an unfortunate spike in findings. Areas of improvement included developing an appropriate understanding of the issuer, coaching at both the engagement team level and the engagement team member level, and monitoring. The major areas of findings are the same as they were in the last cycle, she said: internal controls over financial reporting, assessing the risk of material misstatement, and auditing accounting estimates and fair value measurements.

Looking towards the next inspections cycle, Munter advised that the staff will be looking at the implementation on the Board’s new standard on transparency, including new Form AP, which requires auditors to include the name of the engagement partner on the audit and the names, locations, and extent of participation of other accounting firms who performed work on the audit. She encouraged firms completing the new form to reach out to the PCAOB staff for assistance.

Inspections will also focus on international audits, she said. Because mandatory auditor rotation is in place in Europe, there will be shifts in work around the globe. The staff also expects that audit committees will be looking at auditor rotation. Inspections of international audits will include referred work, Munter advised. She added that the staff will continue to perform joint inspections with other regulators around the world.
Broker-dealer auditor oversight will continue to be an inspection priority, according to Munter. A recent PCAOB report found that broker-dealer audits continue to have a high level of deficiencies, especially regarding independence issues. Related party transactions are a particular area of concern regarding the audits of broker-dealers, according to Munter.

Enforcement. Modesti said that so far in 2016, the Board has made public a record 47 settled disciplinary proceedings, which sanctioned 150 registered firms and 153 individuals. He highlighted the Board’s disciplinary proceeding against a former Ernst and Young partner who acted recklessly in auditing the financial statements of the U.S. subsidiary of an Israel-based pharmaceutical company. It was the first PCAOB disciplinary proceeding against a Big 4 audit partner that had proceeded through to an appeal before the SEC. The former partner had challenged the Board’s proceedings on constitutional and procedural grounds, but not the Board’s finding of liability or its imposition of a $85,000 penalty and an associational bar. The SEC sustained all the Board’s findings, and the former partner is now appealing the case to the DC Circuit, Modesti reported.

According to Modesti, the Enforcement Division’s priorities have been investigations involving a lack of professional skepticism; independence and integrity audit matters; matters threatening the integrity of the Board’s oversight; and risks associated with cross-border audits.

Regarding the Board’s cross-border audits priority, Modesti outlined recent enforcement actions in which the PCAOB obtained settlements in cross-border matters. These included two actions against Deloitte’s affiliates in Brazil and in Mexico. The action against Deloitte (Brazil) resulted in an $8 million civil penalty, the largest ever imposed by the PCAOB. Eight individuals were also charged, the most ever in a PCAOB investigation. The firm admitted that not only had it violated PCAOB standards, it also actively obstructed the staff’s investigation by altering work papers and making false testimony under oath.

Deloitte’s Mexico affiliate agreed to pay a $750,000 penalty for failing to implement quality control policies for audit documentation, Modesti said. Two former partners were also sanctioned for the improper alteration of work papers, which they also had made available to PCAOB inspection staff, Modesti explained.

According to Modesti, these cases demonstrate the need for a strong disciplinary body over the auditing profession to ensure no one acts above the law, even if the overwhelming majority of auditors play by the rules. The staff’s tolerance for the improper alteration of audit work papers is zero, he warned. Globalization, he said, results in unique audit risks that can surface in areas such as the execution of the audit by affiliated network firms as in the Brazil and Mexico Deloitte proceedings. Modesti expects the Division to be very active on the international front in 2017.