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Deputy Chief Accountant Discusses Standard-Setting, Independence and Inspections

In a March 22 speech at a USC corporate governance summit, SEC Deputy Chief Accountant Zoe-Vonna Palmrose talked about the implications of the PCAOB choosing not to delegate audit standard setting to one or more outside professional accounting groups as allowed under the Sarbanes-Oxley Act. The experience that resides within audit firms is relegated to one of a number of constituencies that provide input into the PCAOB's standard-setting process, she said. Practicing auditors are not an integral part of the standard-setting process, which increases the likelihood for ambiguity, misinterpretation and uncertainty in the implementation of PCAOB standards, in her view. Her remarks are posted on the SEC's Web site.

Palmrose said that another implication of the PCAOB's standard-setting decision is that there are now two U.S. standard-setting groups, including the Auditing Standards Board. The International Auditing Standards Board is setting standards in the international arena, which may one day be adopted in the EU. There is a lot of discussion about the international convergence of accounting standards, she said, and auditing standards should be included in the discussion. In her view, there may be fewer compelling arguments for divergences in auditing standards than in accounting standards.

Palmrose also pointed to a lack of convergence in independence standards which creates challenges for audit firms with multinational clients. The Office of the Chief Accountant is working with other securities regulators to survey independence requirements throughout the world. Once the staff has an understanding of the similarities and differences, Palmrose said regulators can engage in a constructive dialogue going forward. Meanwhile, she said the staff is considering the best way to communicate the SEC's and PCAOB's independence rules to audit committee members to help them fulfill their responsibilities under the Sarbanes-Oxley Act. The SEC may have some materials available soon, she said.

Palmrose also discussed PCAOB inspections. She noted that many are worried that the inspection process will continue to result in an overly conservative application of the new internal control standard, once it is adopted. Commenters have expressed concerns that unnecessary audit work will continue and that the auditing standard will continue to drive management's evaluation process because of the PCAOB's inspections.

Palmrose observed that the Sarbanes-Oxley Act made the inspections a key element of the audit regulatory oversight process. However, she suggested that the Act envisioned the inspections to assess compliance as a floor for auditor performance, rather than a ceiling. The inspections should assess audit effectiveness, rather than audit efficiency, she explained. Everyone wants "just right auditing," she said. Palmrose believes that high quality audits can be achieved by approaching the process with intellectual honesty, where disagreements are not viewed as second-guessing during the inspection process.

Palmrose believes that investors are best served if regulators concentrate on audit effectiveness. Rather than have efficiency inspections that focus on individual audit firm inefficiencies in the conduct of their audits of internal control over financial reporting, she said the task could be reframed as a mechanism to better inform both audit standard-setting and auditor performance. The inspections could serve to alert standard-setters to areas that may need clarification or revision, or those that may require new guidance. Inspectors could identify best practices and communicate them to all firms.

Facing the challenges related to audit policy will require the cooperation of regulators, investors, issuers, auditors and others, including academics, according to Palmrose. The goal is simply to improve the quality of financial reporting and auditing, she said.