Saturday, January 27, 2007

The Content and Timing of the PCAOB’s Big Four Inspection Reports

Photobucket - Video and Image Hosting The Public Company Accounting Oversight Board (PCAOB) has been the target of extensive criticism for the timing and content (or lack thereof) of the public reports for its inspections of the Big Four accounting Firms. (Prior D & O Diary posts on this issue can be found here and here.) This issue is reviewed at length in a January 26, 2007 CFO.com article entitled “Why The Big Four Are Still a Mystery” (here), and the article is supplemented by an email interview (here) with PCAOB board member Charles Niemeier.

The article reviews the frequent criticisms that the public inspection reports reflect a “lack of context,” because the PCAOB does not publicly reveal how many inspections it conducts on each firm. Without this kind of quantitative data, there is no way to assess how widespread the concerns are. The absence of this information means that the inspection process “is not producing the kind of results that it should for people who are using the results and trying to understand what this means,” according to the former head of Deloitte, who is now the chair of four public company audit committees, and who is quoted in the article.

The delay in reporting the results is also a concern. For example, the reports for the 2005 inspections of Ernst & Young (here) and KPMG (here) were not released until January 2007. The audits inspected were obviously completed substantially before the inspections. The delay gives analysts and others “little leeway in being able to gauge the current performance of an audit firm.”

Niemeier’s response to the concern about the lack of disclosure concerning the number of audits inspected is that it is “not a relevant figure” and “could encourage misleading, superficial comparisons between firms.” Niemeier also is opposed to supplying further details about the audit concerns noted in the inspection reports, even information designed to convey how serious the problems noted were; Niemeier feels this would be inconsistent with PCAOB’s statutory confidentiality obligations.

Niemeier is also opposed to any overall qualitative evaluation of the firms audited, on the theory that this would “divert attention” from the PCAOB’s efforts to identify risks in the audit firm’s processes. With respect to the timeliness of the inspection reports, Niemeier says that the “timing of the reports has been due to internal operational processes” and that “the time between completion of an inspection and issuance of a report should be shorter in the future.”

What to make of all of this depends on the purpose of the PCAOB’s public inspection reports. If, as with Niemeier, you believe the public reports are designed to provide the audit firms with appropriate incentive to remedy noted concerns, then the current process is adequate. But if that is the sole purpose, why bother with public reports at all? Why not simply reserve public disclosure for those concerns the audit firms fail to address during the 12-month cure period? But the reports clearly are made public (at least to the extent they are made public) for a separate purpose, which is to inform. On that score, as the CFO.com article notes, the inspection reports “don’t paint a clear enough picture about what the auditor overseer was probably trying to say in its reports.”

Niemeier’s comments that added information, such as the number of audits inspected, might be misued amounts to an assertion that investors and others can’t be trusted with the information. Clearly, the policy decision to withhold the information is calculated for the audit firms' protection, to the detriment of the investing public. These competing interests ought to militate that the PCAOB should go as far as it could to disclose information consistent with its statutory constraints – and subject only to the statutory constraints. The numerical and evaluative information critics argue that the inspection reports lack are not barred by the statutory constraints. The audit firm’s best protection against vulnerability to adverse information is in their power to control, through their own audit execution.

A good summary of the shortcomings of the PCAOB’s public inspection reports, with links to other sites, can be found on the White Collar Fraud blog, here and here.

Audit Liability Caps: In a prior post (here), The D & O Diary took a look at various proposals to cap auditors’ liability. In a January 25, 2007 speech (reported here), Conrad Hewitt, the SEC’s Chief Accountant, came out in favor of protecting the “major accounting firms” from legal liability if their audit clients become embroiled in accounting-related scandals. Hewitt is concerned about auditor liability because there are only four major accounting firms left. “It’s a concern to us if something should happen to any of the four firms.”

So The D & O Diary wonders – is the PCAOB’s policy on its public reports of the Big Four firm’s audit inspections the product of a similar concern for the survival of the “remaining four?”

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