Board Member and Enforcement Director Discuss PCAOB Developments

PCAOB member Daniel Goelzer and Enforcement Director Claudius Modesti spoke at ALI-ABA's recent conference on accountants' liability. Goelzer addressed the litigation which challenges the Board's constitutionality. The case is pending before the Supreme Court, but Goelzer said it is business as usual at the PCAOB. The court challenge relates to how Board members are appointed and removed, he said, so the resolution of the case should not have any implications for the Board's continuing operations. Goelzer believes the Board will prevail in the case, but if it does not, Congress will have to address the appointment of its members. That should not affect the Board's other functions, he said.

Goelzer reviewed the Board's recent standard setting activities. He said the Board was bogged down during its first couple of years of operation over the issue of internal controls. Sarbanes-Oxley Act Section 404(b) is now behind us, he said, so the Board can turn to the nuts and bolts of auditing standards.

Goelzer believes the Board will take action soon on its proposal relating to engagement quality reviews. The Board issued proposals in 2008 and again in 2009, he said, and he thinks the latest proposal strikes the right balance in the functions expected of the concurring partner. Goelzer noted that inspections have turned up failures which the Board believes a concurring partner should not have missed. The new standard should have a material effect on audit quality, in his view.

The staff continues to consider recommendations to require that the engagement partner on an audit sign his or her name. The investor community is interested in imposing such a requirement, he said, and the preparer community sees it as a parallel to the CEO/CFO certification requirement. Goelzer said that either a proposal or a concept release is likely in the near future.

Goelzer also talked about the Board's inspection reports, which he characterized as a dialog with the firms where the staff lays out any issues it discovers in its review of the firm's audits or its internal controls. Goelzer recommended that interested parties read the staff's December 2008 report on large firm inspections since 2004. The report outlines the kinds of deficiencies typically found and where they have recurred. A breakdown in professional skepticism is frequently the cause, in Goelzer's view.

Goelzer suggested that companies obtain an understanding with their auditor that if the company's engagement is reviewed, the auditor will let the company know. The staff sometimes contacts the audit committee chair for information, he said, so companies sometimes find out about their engagement review in that manner. If the staff raises questions about the company's financial statements, Goelzer said he would want to be notified about that.

Auditors of nonpublic broker-dealers were not required to register with the PCAOB under an order issued by the SEC, but that order "quietly expired," Goelzer said, after "the world's most famous nonpublic broker-dealer" was implicated in the Madoff scandal. Auditors must now register which has led to an upsurge in registrations. However, Goelzer noted that the Board is in an intolerable situation because it does not have authority over the auditors of broker-dealers. Pending legislation, H.R. 1212, would extend authority over broker-dealer auditors to the Board.

Goelzer said the staff will conduct an inspection program over these broker-dealers just like public company auditors. The vast majority of auditors have no access to client assets, he said, so the risk is not the same at all of the firms. Goelzer said he hopes that Congress understands the differences in risk levels at the firms and hopes the inspection can be appropriately scaled, but the Board will do whatever Congress tells it to do.

When the inspection report is issued, Goelzer said it offers an occasion for a dialog with the auditor if the company is a subject in the public or nonpublic portion. He believes a company would want to know the Board's concerns.

Modesti reported that the Board's investigative plate is full. He reviewed a number of the Board's recent enforcement actions. Goelzer noted that the Board is sometimes subject to criticism that it does not bring cases against the large firms or that it does not bring enough cases, but said no one knows who or how many the Board is investigating because that information is confidential.

Modesti said it is not sufficient to look at auditors' deficiencies. The inspection staff also looks at firms' internal control processes and procedures. If a firm has an internal inspection process, the staff will look at the result of the review and what the firm did in response to its findings.

Modesti described a process which he has introduced in the enforcement area to assist in the dialog with a person whom the Board intends to refer for charges. The staff issues a charging letter which outlines the facts and the alleged violations. Charging letters provide a good method of internal discipline while also providing the other side with an opportunity to respond, similar to the SEC's Wells process, he said. The charging letters are not required under the Board's rules, but the enforcement staff has adopted the practice.

The Board cooperates with the SEC's enforcement division and tries to divide the labor, according to Modesti. The PCAOB's and SEC's authority overlaps in some instances and Congress did not address how it should be divided. The Board will not pursue certain cases because the SEC has them covered, he said.

During a question-and-answer period, Modesti was asked if auditors may raise objections during PCAOB examinations. Modesti said it is helpful if the practitioner is not sure that the Board has established a foundation for its findings. He said the staff has no problem working through those issues, but has an issue where a party uses objections to slow an inquiry. He urged parties to go off the record and have a discussion with the staff if they see a troubling pattern.