And the earth was without form, and void;
And darkness was upon the face of the deep.
-- Genesis 1:2
After His six efficient days of work, “the heavens and the earth were finished, and all the host of them” (2:1), and the great Creator took Sunday off.
Whereas the Public Company Accounting Oversight Board labored fully six years to issue its December 15 release – new rules and a new Form AP by which auditors of US public companies must identify their lead engagement partners.
As examined in my recently-published book, “Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms”, partner naming is a half-baked solution in search of a real problem. In the world of finite regulatory energy and resources, the project has never been worthy of the effort.
To start -- engagement partners in Europe and elsewhere have signed their firms’ reports for years, with no visible evidence that audit quality has been affected one way or the other – much less for the better -- and abundant examples that quality there is not demonstrably above that in America.
Conversely, for all the to-and-fro, the profession’s resistance based on liability concerns was always doubly undercut: First, by the absence of increased partner exposure outside the US. And second, by the lack of a significant history of claims against the firms themselves, under Section 11 of the Securities Act. The prospect of suits against individual partners must be remote – especially as investor plaintiffs have generally forgone those claims under other legal theories. On the other hand, partner identity has always been readily discoverable in US litigation, so the new Form AP will be insignificant in elevating whatever current exposure a partner may have.
As for this new form, rather than a forthright requirement to sign the audit opinion itself, the PCAOB takes a halfway approach that only a bureaucrat could love – a new required filing, on its own unique timetable – creating one more compliance box to tick and one more item for the inspectors’ checklist. Unmentioned in the discussion is the principle, well known to safety and compliance experts, that even the best-intended quality measures add additional complexity: “one more thing to go wrong” injects an unavoidable if unintended increase in the opportunity for cascading mistakes.
Examples are readily available. A key factor contributing to the Three Mile Island nuclear plant “accident” in 1979 was the confusion between a concealed warning light and the failure of an emergency pressure relief valve. And the highway safety studies are instructive, that while safety barriers and rumble strips may reduce the number of collisions, they also incentivize higher driver speeds, meaning that deaths and damages are greater for those that do happen.
Nor does it withstand scrutiny, that public naming somehow raises the level of partner care or concentration. As noted, Europe’s experience does not include evidence of a quality effect. Instead, partners have never lacked for adequate reasons to be focused and motivated. PCAOB member Lewis Ferguson had it right back in 2011, “As a practical matter, in larger accounting firms, a failed audit or major error in the audit of a significant client, particularly a public company, can be career ending for the audit engagement partner in charge of the audit.”
Advocates of partner naming – Re: The Auditors and Going Concern among them -- point with enthusiasm to the SEC’s orders of December 2, 2015, against the Grants firm and two of its partners – noting that one had kept active engagement responsibility after the emergence of performance quality indicators including the eruption of a major client fraud.
If not outright mistaken, this view misses the proper location of incentives and accountability. That’s because, as I was quoted in Francine McKenna’s blog, “one of the many unlearned lessons from Enron/Andersen is the hostage to fortune that a firm leaves by keeping a problem partner on-line either on the same job or as moved around.”
There’s history. Back in the Enron era of 2001, Andersen had left a senior-level audit practice partner in an on-going performance-related role, after (and in spite of) his prior SEC proceeding -- contributing to the inference drawn by law enforcement officials that the firm was an unrepentant and unresponsive repeat offender.
Further back in my own experience, my law firm defended a Big Eight firm in a whole series of lawsuits, involving the client roster of a single audit partner. He was genial but inept, a virtual Typhoid Mary of exposure – exposures that the firm could have avoided by promptly quarantining this viral at-risk partner whose every job was subject to infection.
On top of all of these reasons, the PCAOB has long had more important fish to fry. Its own member Steven Harris flagged two of them, in his remarks in favor of partner naming – namely, “Modernizing the outdated audit report model, and improving auditor going concern reporting….” Add two more to these, at least: the persistently elusive topic of “audit quality indicators,” and the agency’s long-running exclusion from the ability to inspect audit firms in China.
Until the PCAOB acted at last to resolve the lucid question of when and how its Docket 029, pending from 2009, was ever to end – only knew God.
Now, in context of a full menu of complex tasks, six years of effort only to bring forward the new Form AP has the feel – pardon the oxymoron – of a topic deemed importantly high on a list of the inconsequential.
Perhaps more apt than the Genesis comparison, then, to the PCAOB’s misplaced aspiration, is the 1st century BCE challenge issued in Horace’s Ars Poetica:
What could he produce to match his opening promise?
Mountains will labour: what’s born? A ridiculous Mouse!
Thanks for joining this dialog. Please share with friends and colleagues. Comments are welcome, and subscription sign-up is easy and free, both at the Main page.
Wishing a Merry Christmas to all – or whatever solstice-oriented celebration you observe – and a New Year of peace, prosperity, and compassion for those less fortunate.
And as a holiday gift for your favorite CPA, financial officer, board or audit committee member or financial adviser – “Count Down” is available from Amazon, optimistically for delivery before the 25th, or with only its elves’ short and manageable re-stocking.