The fight over audit quality is getting ugly

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Gone are the days when company bosses could dismiss their non-executive directors, as maverick British businessman Tiny Rowland did in the 1980s, like mere “balloons on a Christmas tree”. Several rounds of corporate governance reforms later, independent board members are not merely decorative, but actually an essential pillar of our trust in the public markets.

The heads of US audit firms, which have an equally crucial role in the integrity of capital markets by checking companies’ accounts, are apparently more skeptical about formalizing external oversight in regulation.

A new rule agreed by the US audit regulator, the Public Company Accounting Oversight Board, will force each of the biggest firms to set up a body to oversee quality control and ensure that at least one person from from outside the company. The rule is part of a larger overhaul of quality control standards that the industry wrote decades ago and are only now being updated by the PCAOB, some 20 years after the agency was created following the Enron scandal.

A number of big firms, including PwC and BDO, are trying to overturn the rule at the eleventh hour, in a move that has raised eyebrows from investor groups, which point out that many firms already boast bodies that sound a lot like what propose.

In June, BDO said it had hired a second external member for its “audit quality advisory board” who “provides input” on its audit quality system as the firm seeks to improve its PCAOB inspection results basic. PwC has even asked global regulators to make it easier to hire more outsiders for its advisory groups and boards, the Financial Times reported in December, saying they help make discussions “less insular”.

However, they are among six major audit firms that, along with the industry trade group, have petitioned the Securities and Exchange Commission to overturn the rule. The Chamber of Commerce also warned that the rule will be in “legal jeopardy” if the SEC does not conduct an independent cost-benefit analysis. The SEC must approve all PCAOB standards before they go into effect, and while it has never overturned audit regulators, the furor has caused it to delay approval.

The PCAOB countered this month with a 28-page defense of the standard, urging the SEC to approve and, at several points, barely concealing its exasperation. “Some firms are already choosing to incorporate elements of independent oversight into their corporate governance structures, and the existence and variety of these roles demonstrate that the implementation . . . the requirement is feasible rather than unrealistic,” he said.

The rule’s specific language requires firms to report to their supervisors on the effectiveness of their quality control system, and for the supervisor to evaluate “significant findings made and related conclusions reached by the firm” in that report. The PCAOB called this a “baseline.”

By turning voluntary advisory boards into mandated oversight functions, the PCAOB explicitly increases the demands on outside members, meaning they will need to be paid more and carry professional indemnity insurance. Some opponents of petitioning the SEC believe the extra layer of oversight isn’t worth it.

But most argue only that the PCAOB has not done enough to establish exactly how the new oversight function should work. The PCAOB, under Biden administration appointee Erica Williams, found more violations of auditing standards and fined auditors more for them. Firms are concerned that agency inspectors will scrutinize the work of the new watchdogs for violations and other opportunities. The financial stakes are higher and trust lower than in the past.

In other circumstances, this should be able to be resolved with written guidance from the agency before the rule goes into effect and a post-implementation review if there is evidence that it needs to be adjusted.

But the industry is in no mood to back down. As part of the PCAOB’s efforts to update decades-old standards, several changes are coming as a result, including a new rule that requires firms to take additional responsibility for rooting out fraud and noncompliance at the companies they audit. Some see this as a moment to remind the PCAOB that it needs to dot every i and cross every t.

Williams likes to say that her PCAOB uses “all the tools in our toolbox” to hold audit firms accountable. Now she finds that firms are using every tool at their disposal to slow her down.

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