The PCAOB Hates Altered Documents – Stop Giggling, and Listen Up

 

“(W)hoever, in any matter within the jurisdiction of the executive, legislative, or judicial branch of the Government of the United States, knowingly and willfully—

(1) falsifies, conceals, or covers up by any trick, scheme, or device a material fact;

(2) makes any materially false, fictitious, or fraudulent statement or representation; or

(3) makes or uses any false writing or document knowing the same to contain any materially false, fictitious, or fraudulent statement or entry;

shall be fined under this title, imprisoned not more than 5 years….”

-- 18 US Code Section 1001

What part of this venerable provision of the American criminal code is hard to understand? When government agents come calling, they expect the whole truth. It will not go well – however irritating may be an authority’s intrusions -- to mess with a power that holds hostage your license, or your liberty.

So what could have been behind the Public Company Accounting Oversight Board, the American audit regulator, with its April 21, 2016, announcement of a Staff Alert, expressing “concerns about auditors improperly altering audit documentation in connection with a PCAOB inspection or investigation”?

Since its birth with the Sarbanes-Oxley law of 2002, the PCAOB has punched below its weight, with a history of small-bore initiatives of marginal credibility and nominal effect: after years of effort it finally caved on the foolish notion of mandatory auditor rotation; its requirement of a new form by which to identify lead audit partners satisfies nobody; it remains impotent and unable to function in China; and the scalpel it is taking to the basic language of the standard auditor’s report cuts not to the jugular but to the capillary.

What point is there, then, in another exercise in admonitory finger-pointing – unlikely to be of any more impact?

The practice quality and risk guidance of any accounting firm subject to PCAOB oversight should already be clear, beyond any possibility of ambiguity or misinterpretation, on the vital importance of the integrity of working papers – it demeans the expertise and the responsibility of the firms’ senior leaders to suggest otherwise.

History should teach, after all, that the cover-up is often worse than the crime. Gangster Al Capone went down not for his years of violent bootlegging, but for tax evasion; for Alger Hiss it was perjury, not espionage; Richard Nixon’s record of presidential malfeasance in office lay exposed by a bungled burglary in the Watergate apartments.

And right at home – it was the financial impact of Enron’s collapse that rendered Arthur Andersen a terminal patient on life support, but it was the shoddy exercise of document shredding in its Houston office by which the Justice Department pulled the plug.

And the Alert says the same:

The consequences of providing improperly altered audit documentation to PCAOB inspectors or investigators may in many cases be far more severe than would be the consequences of the PCAOB staff identifying the audit deficiency that the revisions to the documentation attempt to obscure.

Which said, fallible humans operating complex systems will suffer inevitable short-comings in performance. There is no perfect set of audit working papers, and the inspectors are well known as fine-screen fuss-budgets. So when the PCAOB comes calling, it’s as with Samuel Johnson’s observation that “when a man knows he is to be hanged, it concentrates his mind wonderfully” – the temptation is intense to buff up and polish the files. Especially for audit teams in subsidiary or foreign locations, who lack first-hand experience with the consequences of being caught out.

Properly advised, however, auditors under inspection pressure have an explicit avenue to both forgiveness and redemption. The Alert itself quotes the PCAOB’s standards (emphasis added and footnote omitted):

Audit documentation must not be deleted or discarded after the documentation completion date, however, information may be added. Any documentation added must indicate the date the information was added, the name of the person who prepared the additional documentation, and the reason for adding it.

With such an emollient invitation to transparency, recourse to file-fixing should be a non-issue.

Which does however go back to the PCAOB’s motives: has it so little respect for the auditors it inspects, or does it launch such an inflated warning signal for the sake of puffing its own modest enforcement authority?  

Either way, audit firms are well advised to treat the Alert with serious sincerity – because lurking behind the PCAOB’s evident self-regard, it has sanctions available that are far more emphatic than the disciplinary tools in its own Lilliputian kit – namely, the option to refer cases up to main Justice for criminal prosecution under the above-quoted provisions of 18/1001.

Put another way, Voltaire may have had it right back in 1759, when he mused that it would be good from time to time to kill the occasional malingering admiral, “pour encourager les autres” – and that’s a risk no auditor should run.

 

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Comments

[Herb Chain]

Clearly, the APA was generated by egregious alterations of working papers to be subject to inspection. You are right that the concept is fundamental to law and professional standards. Inspections must have revealed significant noncompliance to warrant such a release.

Professional standards allow changes to working papers after the release of the report, if properly documented (as you note). Typically, this would result from omitted procedures, possibly resulting from an inspection deficiency (PCOAB, Peer Review, or internal).

And, again as you note, the cover up is often worse than the crime.