Tuesday, October 11, 2011

PCAOB Proposes Disclosure of Engagement Partner, Other Firms In Audit

Earlier today, the Public Company Accounting Oversight Board voted to release proposed amendments to its standards to require disclosure of the name of the audit engagement partner, and disclosure of certain other persons and firms associated with the audit. The PCAOB’s press release and related documents are linked at the bottom of this post.

The proposal follows from a recommendation of the U.S. Treasury Advisory Committee on the Auditing Profession published in 2008, and a PCAOB Concept Release issued in 2009, including consideration of comment letters received on that Concept Release, and input received by the PCAOB by its Standing Advisory Group, Investor Advisory Group, and others. For background, particularly regarding the move to require ‘disclosure’ vs. ‘signature’ by the engagement partner, and a discussion about potential liability issues arising from such disclosure or signature, see our earlier blog post.

PCAOB Chief auditor Marty Baumann outlined today’s proposal as requiring disclosure of the:
· Name of the engagement partner [to be disclosed], in the audit report
· Name of the engagement partner, [to be disclosed] in the annual report filed by each registered audit firm with the PCAOB [Form 2]
· Names, locations, and extent of participation of other persons and firms who took part in the audit

Disclosure Of Engagement Partner For Most Recent Audit Period Only

Dima Andriyenko of the PCAOB staff said disclosure of the engagement partner signature would be required by adding the following sentence to the auditor’s report: "The engagement partner responsible for the audit for the period ended [date] was [name of engagement partner]."

He also noted that while the audit report relates to financial statements of more than one year; based on comments received on the earlier Concept Release, the PCAOB’s current proposal recommends disclosure of the engagement partner for the most recent period’s audit only.

3% Threshold For Disclosure of Other Audit Firms, Persons
Lisa Calandriello of the PCAOB staff explained the scope of the proposed requirement to disclose the names and locations of other independent accounting firms or persons who participated in the audit, and how that determination is to be made with respect to considerations relating to contractual relationships with those other persons/firms, and with respect to taking responsibility as the “principal audit firm” for work performed by other audit firms/persons as described in AU 543, Part of Audit Performed by Other Independent Auditors, or in a supervisory role as specified in AS 10, Supervision of the Audit Engagement.

Calandriello described a 3% threshold for determining whether another audit firm/person needed to be disclosed: "If the percentage of total audit hours [performed by another person or audit firm] attributed to the audit … is 3 % or more, then this firm or person [would be] disclosed separately. [The proposal], would not require separate disclosure of firms or persons whose participation is below3%, such firms or persons would either be disclosed as a group, or disclosed separately, as determined by the audit firm issuing the audit report."

Unanimous Vote; 90-Day Comment Period
The board voted unanimously in favor of releasing for public comment the proposal on disclosure of the engagement partner and certain other firms/persons involved in the audit. The staff recommended, a 90-day comment period, noted Calandriello; ending Jan. 9, 2012.

Comment Sought On Legal Liability, Disclosure Of Additional Parties
The board members’ opening statements, and in particular, the Question and Answer period between the board members and staff, highlighted a number of issues on which there is still some uncertainty and/or the board is specifically seeking comment in the proposing release.

Will disclosure of the engagement partner, as required in the proposing release (or an engagement partner signature, as still preferred by board member Steve Harris, although he concurred with issuing the proposing release) increase the personal liability of the engagement partner? Matters specifically discussed in the Q&A, particularly in questions posed by board member Dan Goelzer (a lawyer) and board member Jay Hanson (an auditor, who asked for a ‘plain English’ explanation of the legal issues), and in responses provided by the PCAOB’s General Counsel, Gordon Seymour, centered on liability as enforced by the SEC under Securities Act Section 7 and Section 11, and liability under the anti-fraud provisions of Section 10b, particularly in light of the recent Janus decision [Janus Capital Group, Inc. v. First Derivative Traders, 131 S.Ct. 2296 (2011)], as to who the ‘maker’ of a statement is.

Here is an excerpt from the discussion re: engagement partner liability: GOELZER: Let’s turn to liability, the elephant in the room. Treasury ACAP said signature should not impose any greater liability on the partner than they would otherwise have; ACAP went on to discuss possibility of the SEC offering a safe harbor; does the [PCAOB] staff believe the switch from [considering requiring an engagement partner] signature to disclosure [of the name of the engagement partner] would obviate the need for a safe harbor? PCAOB GC GORDON SEYMOUR: ACAP referred to the possibility of a safe harbor regarding Section 11 of the Securities Act of ’33. The SEC administers Section 11, [and the SEC] would have to decide if … [disclosure of the engagement partner] would subject that individual to Section 11 liability, which raises in turn whether the SEC would promulgate a safe harbor; yes, that’s an issue, we’ve had discussions with the SEC, as to their willingness to promulgate a safe harbor, [it is not yet determined], we’ll continue to have discussions with the SEC staff. GOELZER: Section 11 is under the SEC’s control, whether or not they’ll accept a Section 7 consent, that will drive Section 11 liability. …

SEYMOUR [later, in response to question posed by board member Jay Hanson]: There are two provisions in the Federal Securities laws, that could be enforced b y regulatory, and private actions, Section 7 and 11 work in tandem, Section 10b is another, 10b is a fraud based claim, the recent decision in Janus clarifies who the ‘maker’ of a statement is; at the time of [the board’s 2009] Concept Release on an [engagement partner] signature requirement, the law was more uncertain, predated Janus, many commenters thought a signature requirement would make the signer the ‘maker’ of the statement; , we have questions whether there are implications post-Janus on signature requirement; Section 7 and 11 [of the Securities Act] relates to securities offerings, companies [e.g. audit firms] named in a registration statement have to file a ‘consent’ and therefore have potential liability for statements potentially false in the that registration statement; the issue is whether the SEC would require a Section 7 consent; it is clear today an audit firm would be such an expert and face that potential liability, the only issue here is whether the SEC would also see that individual as an ‘expert’ if they are seen [disclosed] in that audit report, therefore that individual could face liability [under Section 11] if they couldn’t show they acted with due diligence. The SEC could issue a safe harbor rule, we understand ACAP recommended [that].

Another issue discussed in the Q&A at the board meeting, on which the PCAOB specifically seeks comment in the proposing release, is whether disclosure of any additional partners should be required, specifically, the Engagement Quality Review [EQR] partner, or the ‘Appendix K’ review partner. As explained by Deputy Chief Auditor Jennifer Rand: “there are certain exceptions to disclosure of other firms or persons, EQR is one, Appendix K review [is another, as well as], specialists, internal audit, use of work of others. Lisa also talked about the construct of disclosure in 1 of 2 buckets: those firms you take responsibility for under AU 543, the other is under AS10 [which] the board issued a year ago…. [In contrast] Engagement quality review is intended to be an objective look at the audit; outside the audit, that person does not perform audit procedures, not involved in role of performing audit work; [but] making sure the opinion was appropriately issued; we thought under construct of AU 543 and AS10, EQR didn’t meet that construct, the release includes questions whether eng quality reviewer should be disclosed.” In response to a question from Chairman Jim Doty on why the ‘Appendix K’ review partner was excluded, Rand replied: “Appendix K is a requirement the board adopted in 2003 from the AICPA’s SEC practice section, which had requirements that went to its member firms; Appendix K requires firms that had been members of the SEC Practice Section to have filings reviewed of foreign affiliated firms before it comes into the US market, to have someone knowledgeable about U.S. rules [conduct a review].” She said the reasoning behind not requiring disclosure of Appendix K review partner was similar to that in not requiring disclosure of the EQR partner.

3% threshold for disclosure of other firms or individuals (outside the principal audit firm) performing part of the audit: In response to a board member’s question, Baumann noted that the 3% figure was arrived at after the staff concluded there should be a threshold, and they determined the 3% threshold to be reasonable for this purpose. Staff pointed out the 3% threshold differs from the board’s 20% threshold which determines which audit firms must be registered with, and inspected by, the PCAOB (firms performing 20% or more of audits of a public company). Therefore, some nonregistered audit firms may be disclosed under this proposals 3% threshold, and some registered audit firms involved in less than 3% of the work on a particular audit may not necessarily be disclosed in that particular audit report.
Information will be searchable: in response to a question from Goelzer, PCAOB staff member Mary Peters said that the names of engagement partners as disclosed in PCAOB’s Form 2 will be searchable on the PCAOB website.

Will Enhanced ‘Accountability’ Mindset Drive Increase In Audit Procedures, Cost?
Also during the Q&A , board member Daniel Goelzer raised a specific line of questions on the subject of cost-benefit, centering on whether changes in attitude (i.e., a presumed enhanced sense of ‘accountability’ on the part of an engagement partner whose name was disclosed) would lead to changes in behavior, and specifically to changes in audit procedures – which could in turn potentially drive increased costs. Although PCAOB staff said ‘no new procedures’ were required under this proposal (which could potentially be used to assert no additional costs were likely to arise), the potential for the engagement partner to drive increased procedures that result in simply covering their liability, but do not add to audit quality, and the potential for increased audit procedures that actually increase audit quality, is certainly there, and is something that commenters may want to consider.

Following are some excerpts from the Q&A during today’s PCAOB board meeting, regarding cost-benefit of the proposal for disclosure of the name of the engagement partner: GOELZER asked Baumann to describe the ‘specific behavioral changes the staff expects from a signature or disclosure requirement. ‘ BAUMANN replied that the staff ‘expect it would enhance a sense of accountability; ….inspection results show there is room for substantial improvement in professional skepticism and other areas, and the enhanced accountability from a disclosure of the engagement partner is expected to [be helpful].” ANDRIYENKO added that ‘the proposal does not require any additional audit procedures.’ GOELZER: “Do you plan to do a cost/benefit analysis, if people are going to perform audits differently, I think there has to be some analysis of the costs.” BAUMANN: “On the surface, inclusion of [engagement partner] signature would require no cost; whether the auditor suddenly feels he or she has to perform more procedures just because their name is there, … as to the assertion we heard from the [audit] firms that they already felt accountable signing the audit firms’ name, whether additional procedures [in some cases are necessary].. that would be a positive benefit; additional costs are not quite known. We are looking for input on this proposal on issues of cost and benefit.” GOELZER: [As referenced earlier in the meeting and in the proposal] the EU requires signature of [engagement partner]natural person on audits, do you know if there has been behavioral research on changes from that? BAUMANN: audit quality is a very hard thing to define; measuring improvements in audit quality is a difficult thing, a period of time is needed to assess improvements, there isn’t a lot of history whether engagement partner signature [in the EU] has changed audit quality; one study showed no apparent change, but those researchers used ….. things that are not necessarily linked to audit quality. “ANDRIYENKO : “One study on the effect of engagement partner signature in one European country; failed to document any relationship in audit quality based on parameters of the study; however, [the study also] failed to unconditionally conclude there is no relationship between audit quality, changes in audit quality, and [the EU] requirement for engagement partner signature.” GOELZER: It seems to me there are several things going on, one is whether they [the engagement partner] would feel more accountable, one is whether they would act differently, .. whether they are doing self protective things that wouldn’t improve audits, staff should [look at that]. The other is disclosure/transparency matter; [for example] you know who [a public company’s] directors are, officers, a lot of information required to be disclosed about people involved with public companies, do you know if the SEC has ever considered requiring disclosure of the names of engagement partners? PCAOB staff: “The SEC staff talked about some matters staff was considering, they had not presented it to the commission, I am not aware if that has advanced to the commission; not aware of other activity.”

Links to PCAOB Documents

The following documents relating to today’s PCAOB board vote to release proposed amendments requiring disclosure of the name of the engagement partner, and disclosure of certain other firms and individuals (outside the principal audit firm), have been issued by the PCAOB:
PCAOB Press release Oct. 11, 2011
Statement of Chairman Jim Doty
Statement of Board Member Dan Goelzer
Statement of Board Member Lew Ferguson
Statement of Board Member Steven B. Harris
Statement of Board Member Jay Hanson
Watch for a link to the proposed rule (and the archived webcast) to be posted here.


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