There are at least two positive reasons for attention to the New York speech delivered on May 5 by the PCAOB’s newbie chairman James Doty – here.
Although no rhetorical threat to the real wordsmiths of the Beltway, Doty has the ability to turn an adult phrase -- finally re-writing the agency’s longstanding pattern of turgid language and opaque vision.
As can be seen, first, in his readiness to reject the “structural alternatives such as a third-party payor or insurance-based system,” or to see the trial balloons floated in the UK or in Brussels to break up the Big Four – properly “the bailiwick of competition authorities” – as having a “negative effect on audit quality.”
Second, Doty offers relief at last – although perhaps inadvertently -- from the otherwise reluctant but compelling conclusion that since passage of the Sarbanes-Oxley law in 2002, the PCAOB has managed to pass from immature ineffectiveness directly to self-perpetuating inertia without ever achieving a record of real accomplishment.
Namely, a healthy admission of the agency's inward focus is at least implicit in Doty’s acknowledgement that auditor oversight and quality enforcement are shrouded in PCAOB confidentiality and concealed from public transparency and deterrent impact. The same inference is recognizable in Doty’s reference to recently commenced “joint inspections with U.K. and Swiss authorities” – surely two of the lowest-hanging fruits dangling from the limbs of cross-border enforcement – only showing the glacial pace of progress over nine years.
Meanwhile for candor and completeness, his concession of an inability “to inspect a registered firm’s work” in context of the “growth in the number and size of Chinese companies seeking access to capital in U.S. securities markets” requires acknowledgement of this year’s outbreak of litigation claims against Chinese issuers – catalogued by the ever-informative Kevin LaCroix’s D&O Diary, and the risk-based subtext of the PCAOB’s own March-dated research note.
Credit as due for these positions, but the Chairman ventures onto even riskier ground.
To start, his cheerleading that the auditors’ “lofty status” as “guardian of a cultural value” is akin in importance to electricity or water, presumes to invoke the name and record of the late chief accountant of the SEC. But the legacy of Sandy Burton’s 1980’s advocacy for greater auditor responsibility only highlights the absence of substantive change over the span of an entire generation.
Likewise, Doty’s critique of the payment model by which “the auditor is hired and paid by the company itself” is devoid of vision for change in a structure embraced since the emergence of independent assurance to assist shareholders in the Victorian era of the 1850’s.
The market's vote for persistence of “client pays” does not fault the limited influence of audit committees on economic relationships having 150 years of history, pace Doty’s slap at their lack of impact. The durability of that model and the absence of viable alternatives only expose, instead, the intellectual fragility of the entire cosmetic attempt to regulate “appearances of independence” and the richly-deserving consignment of that sacred cow to a decent burial (as I have written for years – see here and here).
Rather, it is the narrow and anachronistic language of the current compliance-oriented audit report itself – a document having value in today’s environment not by the free choice of issuers or users but only because required by the fraternity of regulators to which Doty himself belongs – that operates as a shackle on innovation.
Here Doty stands exposed. Correctly recognizing that “auditors don’t have a natural incentive to evolve their reports to what investors want” – a position long argued (e.g., here, here and here) – Doty has put down a major marker: He promises a “concept release” for early summer, to consider “how the auditor’s report can be changed to provide more useful, relevant and timely information.”
Can the Chairman really mean it? And how, without conceding that his own agency (along with the SEC) holds the keys to the lock?
He avows that “there is no silver bullet to address these challenges.”
But in this he is wrong. That bullet today is loaded in the deadly weapon of litigation roulette, which aims existential exposure at the large firms for their issuance of the very reports Doty purports to recognize as failing to deliver value to users.
To disarm that weapon – to create and nourish an environment in which real innovation in assurance and investor value can be brought forth – will require a leader's brave step, up to now unimaginable: scrap as worn-out and useless the obsolete one-page compliance report, along with the devastating machinery of liability that has grown to encage it, and start with fresh and creative authorship, written on an entirely blank page.
The first PCAOB chairman left office with the admission that regulators “don’t have a clue”(here). Today's occupant not only has the opportunity to show otherwise. Doty's speech makes hostage to fortune and accountability in office his own readiness to act.
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