Even as the new year will likely bring the defenestration of Erica Williams, chair of the Public Company Accounting Oversight Board, that agency has tossed up to its over-seer, the Securities and Exchange Commission, proposed rules that would – in the unlikely event of SEC approval - require registered audit firms to bring forth volumes of details on their performance metrics.
Views differ on both the wisdom of the rules themselves and the extent of the capital markets’ appetite for details on the operations of the world’s large public companies’ auditors. But pass the basic question whether any of the proposed disclosures would guide investors in handicapping a “good” or “bad” audit. There are at least three reasons why the rules are untethered from the realities of the Big Audit model.
First is the expected SEC disapproval – either entirely, or in anything like the rules’ current form. Paul Atkins, nominee to succeed Gary Gensler as SEC chair, has made well known his hostility to the PCAOB and the recent scope of its activities. Spelled out in detail by Mark Maurer in the Wall Street Journal for December 9 is the likelihood that Atkins will return the agency into the deep retreat that marked its somnolence under Williams’s predecessor.
The coming months will tell whether chair Williams might get her way, in bringing live any of the expansive reporting and data collection, but it’s a reasonable wager that with the changing of administrations in Washington in January, she will be out of a job and her proposed rules will waste like flowers in the desert air.
Second is the deep divergence on the value of the information to be required. Chair Williams had put it that the cascade of information “would provide investors, audit committees, and other stakeholders with valuable information on firms and their engagements to help them make knowledgeable decisions regarding audit firms and investment-related choices.”
The accounting firms themselves are in vigorous opposition, set out by the Center for Audit Quality, speaking for the large firms,in a series of letters (June 7, November 11 and November 22, 2024), “based on public policy concerns, lack of cost-benefit analyses and the likely negative competitive impact to the US public company audit profession.” And the AICPA, with focus on the smaller firms, wrote in its letter to the SEC of December 19, 2024 that “these rules will have unintended negative consequences, including driving small and medium-sized firms out of the public company auditing practice.”
Chiming in was Bob Conway, whose credentials span his long tenure as a KPMG partner and senior staff positions at the PCAOB. In early December he brought to YouTube and to Francine McKenna’s substack, The Dig, his view regarding the familiar, standard and amply criticized auditor’s opinion required for public companies by the SEC, about which he says that “commodity pricing is the culprit.”
With respect, Conway’s endorsement rests on flawed premises, beginning with the problem that pricing power for a commodity product is limited. The language of an audit opinion, prescribed by and acceptable to the SEC, prevents differentiation even as it confines the auditors in golden handcuffs. The form of that opinion - the core product of the firms’ assurance practices, with wording compelled by law and regulation - is expected by a generally indifferent user population, invariant across the critically small number of provider firms.
In this market, not only do the firms lack pricing power. Neither they, their clients, nor the providers of capital have any incentive to change. Typical retail investors could not identify the auditors of companies in their portfolios, much less distinguish one firm’s opinion from another, while investment professionals and audit committees alike already have access to as much information as they may deem significant.
Nor does the limited scope of available auditor choice allow for what Conway calls “informed decision making (by audit committees and prospective employees) that will fuel competition on elements other than price.” As reported by Statista, in 2022 the Big Four networks gathered up fully 99.7 % of the audit fees of the S&P 500 companies. In this environment, large public companies lack a range of auditor options under the limitations of the four-firm Big Audit model.
And the prospects for expanding that tetrapoly are nil. If anything, the mid-tier and smaller firms are shrinking or giving up their positions in the public company audit market altogether, for various strategic reasons including the combined influence of private equity and other third-party capital and their own eager appetites for expanded non-assurance revenues.
Nor does Conway’s position gain traction by his invocation of the 2008 activities of the Advisory Committee on the Auditing Profession, convened by Treasury Secretary Paulson in the second term of the younger President Bush.
The output of that group, so riven with discord and animosity as to challenge the leadership of amiable co-chair Donald Nicolaison (RIP 2019), would have been so inconsequential as to die on the vine in any event. The over-whelming impact of the credit crisis, however - already underway although not yet much recognized - was enough to erase from the sands of time any of the Committee’s footprints, faint as they were.
Third and finally, the fine-grained rules that Williams and Conway support would be inflicted on a franchise already confronting change at a more fundamental level for its very survival.
Not that the advocates are necessarily wrong in pressing for greater auditor transparency. It’s a sympathetic argument, that the providers of assurance on the corporate information required of their clients should, for the sake of their own reputations and professional legitimacy, offer the market at least the same disclosures about their own enterprises.
Indeed I have long advocated that the profession should have followed the lead of the Arthur Andersen organization in the 1970s, when for several years it published its own global financial statements, together with the unqualified auditors’ opinion of the firm then branded as Haskins & Sells. (Disclosure/reminder – for nearly two decades I was a member of the Andersen internal legal group and a worldwide partner, retiring the summer before its Enron-driven collapse.)
It's that the value of the standard commodity auditor’s opinion has been in demonstrable decline for years:
- Going back to the crisis in the US savings & loan sector in the 1980s.
- Through the negligible impact of the post-Enron passage in 2002 of the Sarbanes/Oxley law on the credit crisis that followed in 2007-2008.
- Lately with the ever-increasing volume of activity in financial markets outside the reach of the Big Audit model:
- Manifest in such scandals as Theranos and FTX.
- The passion with which activity in the crypto-sphere has exploded.
- The outbreaks of dubious corporate behavior that back-footed the regulators in the form of the reverse-IPOs of companies in China and the groundswell of registrations based on mergers with special purpose acquisition companies.
While at the same time, the degree of enthusiasm for reporting and assurance under the broad heading of Sustainability has turned the heads of strategists and commentators, occupying energy and resources elsewhere than in the profession’s traditional practices.
Even assuming that in some revised form the PCAOB’s inspection and enforcement activities may trundle inexorably onward, the structure of its legislative mandate means that its reporting of inspection results and enforcement outcomes is at best partial and opaque, while actual improvement measurement remains elusive. Inspection deficiency rates as reported by the agency itself continue to attract the rhetoric of official dissatisfaction (as put by chair Williams herself, in 2023 and again in 2024).
Informative and useful academic research is still to be delivered, with adequate sample sizes and coverage at scale of the large public companies, by which to assess and evaluate any actual impact on audit quality over the history of the PCAOB. A catalogue of issues - partner naming and opinion signing, scope of practice limitations, reporting of key or critical audit matters, and (in the UK and the EU) mandatory auditor replacement or rotation - remain to be tested.
Participants with self-interests offer each other the predictable exchanges of mutual reinforcement - claims that “things are better than they were before.” What is not asked is the more disciplined question, “are things better than they would have been if Sarbox had never been enacted” – an alternative scenario under which a market-cleansing process could have allowed legitimate concerns over audit quality, corporate reporting and investor protection to be sorted out through performance criticisms, enforcement proceedings and damage claims under the still-salient application of the antifraud provisions of the core securities laws.
Simply put, the PCAOB’s proposed metrics disclosure rules might, if put into place, satisfy some bureaucratic appetite for data-gathering, in answer to a need that nobody really feels, in a flurry of motion in the guise of progress. As expressed in the CAQ’s skeptical letter of June 7, however, “without a sufficient understanding of how – or if – investors would use the information presented in the proposed metrics (and taking into account the risk of inappropriate use), it does not seem appropriate to suggest that investors would use such information to make investment and proxy decisions.”
Instead, under a market-oriented test of utility or good effect, the fate of the proposed rules would resemble the shipboard orchestra mournfully performing on the sinking stern of the Titanic.
Thanks for joining this dialog. Please share with friends and colleagues. Reactions and comments are invited and welcome, and subscription sign-up is easy and free, both at the Main page.
Comments