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SEC, PCAOB Staff Will Revise Proposals on Internal Controls

The SEC held a special open meeting to discuss potential revisions to its proposed guidance for management in assessing internal controls over financial reporting and the Public Company Accounting Oversight Board's proposed Auditing Standard No. 5 on auditing internal controls. The commissioners heard the views of PCAOB Chairman Mark Olson, Jeff Steinhoff of the Government Accountability Office, SEC Chief Accountant Conrad Hewitt and Corporation Finance Director John White. The staff recommended additional revisions to the proposals and, with the commissioners' unanimous approval, will work with PCAOB staff to more closely align the language of the documents and to make other changes suggested by commenters. SEC Chairman Christopher Cox said he is confident that the proposals remain on schedule.

Chairman Olson reported that the PCAOB received approximately 170 comment letters in response to its proposed standard on internal controls. The letters reflected a broad range of views, he said, with considerable support and numerous suggestions for improvement. The staff has identified ways to revise the proposed standard to provide additional flexibility. Mr. Olson said it is premature to say how the board will act on any given issue since the perspectives of all five members must be considered. He assured the SEC that board members are open to all of the comments and are carefully considering the recommendations.

The PCAOB chairman said the issues commanding the most attention included a better alignment of the board's standard with the SEC's guidance, improvements to the section on scalability of the audit for smaller companies and fewer uses of mandatory or presumptively mandatory requirements, which are referred to as the "must" and "should" requirements.

Mr. Steinhoff, the GAO's managing director for financial management and assurance, said the GAO supports the thrust of the current proposal. The GAO believes the SEC should assess the sufficiency of the guidance in coordination with the PCAOB. If further relief is deemed appropriate, Mr. Steinhoff said it should be targeted and limited. The GAO believes that coordination among regulators and standard setters is important and that they must agree on what is expected. Inconsistencies in core standards can increase costs and cause confusion, he said.

Director White said an analysis of the 200 letters received by the SEC reinforced the critical interplay of the SEC's and the PCAOB's proposals. Chief Accountant Hewitt noted that a major theme of the comment letters was whether the two proposals worked together. Many commenters sent the same letter to both the SEC and the PCAOB. The staff is working closely with the PCAOB to revise their respective documents, he said, and has identified four significant issues that the PCAOB should address before sending a final standard to the SEC for its approval.

Deputy Chief Accountant Zoe-Vonna Palmrose outlined the staff recommendations for revising Auditing Standard No. 5, the first of which is to more closely align it with the SEC's guidance. The staff also recommended improving the section on scalability, clarification of the auditor's exercise of professional judgment, and the application of broader principles in using the work of others. To align the two proposals, Ms. Palmrose said the staff would strive for consistent definitions. She acknowledged that the staff did not appreciate the implications of some of the slight differences in definitions. The GAO sensitized the staff to the importance of converging the definitions, she said.

Commissioner Roel Campos asked Ms. Palmrose to address some commenters' concerns that the revisions are more focused on cost-cutting than investor protection. She said that was not the case at all. The objective is a more effective audit process. The staff does not think about efficiency without considering its impact on effectiveness, she said. Hewitt added that excessive audit costs harm investors, so the right balance must be struck.

Deputy Chief Accountant Palmrose said it is also key that there be alignment within the PCAOB so the inspectors can focus on the standard's objective. The staff must understand how to approach inspections and to communicate results. There are ways to communicate best practices than can benefit a firm, she said. Mr. Hewitt agreed that the PCAOB's implementation of the revised standard is very important. The PCAOB will have to extensively train its staff. The SEC will be looking at the implementation of the standard as it reviews the PCAOB's inspection process.

Nancy Salisbury, with the Office of the Chief Accountant, reported that a number of commenters said it was still unclear how small companies could scale Auditing Standard No. 5 to fit their size and complexity. She said the PCAOB can address some of these concerns when it revises the prescriptive language of the standard. Ms. Salisbury said the PCAOB could also provide better guidance on how the principles could impact the audit. Ms. Palmrose added that the SEC provided guidance in its proposal that was well received, so it may be helpful for the PCAOB to incorporate it as well. Commissioner Paul Atkins said that, given the level of congressional interest on the impact to small businesses, it is critical to get this right.

Chairman Cox noted that the PCAOB has developed a whole new standard on using the work of others and asked why the use of the work of others remains an issue. Ms. Palmrose replied that a number of audit firms said there was no need for a new standard and that the proposal could actually undermine their ability to use the work of others. The PCAOB's laudable intent may not have been executed as intended, she said. Ms. Palmrose added that this is one area in which the comment letters were enormously helpful.