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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Gone are the days when company bosses could dismiss their non-executive directors, as the maverick British businessman Tiny Rowland did in the 1980s, as mere “baubles on a Christmas tree”. Multiple rounds of corporate governance reforms later, independent board members are not just decorative, but in fact a critical pillar of our trust in public markets.
The heads of US audit firms, which have a role just as crucial to the integrity of capital markets by verifying company accounts, are apparently more sceptical about formalising 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 establish a body to oversee quality control, and to make sure at least one person on it comes from outside the firm. The rule is part of a broader revamp of quality control standards that the industry wrote itself decades ago and which 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 kill the rule at the eleventh hour in a move that has raised eyebrows among some investor groups, which point out that many firms already boast of having bodies that sound a lot like what is being proposed.
In June, BDO said it had hired a second external member for its “audit quality advisory council”, which “provides input” on its system of audit quality as the firm tries to improve its bottom-of-the-pack PCAOB inspection results. PwC has even been asking global regulators to make it easier to hire more outsiders for its advisory groups and governing boards, the Financial Times reported in December, saying they help make discussions “less insular”.
Yet these are among six large audit firms that, along with the industry’s trade group, have appealed to the Securities and Exchange Commission to nix the rule. The Chamber of Commerce has also warned the rule will be in “legal peril” if the SEC does not conduct an independent cost-benefit analysis. The SEC must approve all PCAOB standards before they can go into effect, and while it has never overruled the audit regulator before, the furore has caused it to delay approval.
The PCAOB countered this month with a 28-page defence of the standard, urging the SEC to approve and, in a few spots, barely concealing its exasperation. “Some firms already choose to incorporate elements of independent oversight into their corporate governance structures, and the existence and variety of those roles demonstrate that implementing the . . . requirement is feasible rather than unrealistic,” it said.
The specific language of the rule requires firms to report to their oversight bodies on the effectiveness of their quality control system, and for the oversight body to evaluate “the significant judgments made and the related conclusions reached by the firm” in that report. The PCAOB called that a “baseline”.
By turning voluntary advisory councils into mandated oversight functions, the PCAOB is explicitly increasing the demands on external members, meaning they will have to be paid more and provided professional indemnity insurance. Some opponents petitioning the SEC think the extra layer of oversight is not worth it.
But the majority are just arguing that the PCAOB did not do enough to set out how exactly the new oversight function should work. The PCAOB, under the Biden administration-appointed chair Erica Williams, has been finding more infractions of audit standards and fining auditors more heavily for them. Firms are worried that the agency’s inspectors will be poring over the work of the new oversight bodies in search of paperwork violations and other gotcha opportunities. The financial stakes are higher, and trust lower, than in the past.
In other circumstances, this should be resolvable with written guidance from the agency before the rule goes into effect, and a post-implementation review if there is evidence it needs to be tweaked.
But the industry is in no mood to back down. As part of the PCAOB’s push to update decades-old standards, there are more consequential changes coming down the pipeline, including a new rule forcing firms to take extra responsibility for smoking out fraud and regulatory non-compliance at the companies they audit. Some see this as a moment to remind the PCAOB that they need to dot every i and cross every t.
Williams likes to say that her PCAOB is using “every tool in our toolbox” to hold audit firms to account. Now she is finding that firms are using every tool in theirs to slow her down.