PCAOB Focuses on Auditor Accountability to Investors

Seemingly sudden bank failures and massive undetected investment swindles have fueled fresh criticism of the value of independent audits as a way to protect investors. Much has been done since the Enron meltdown and other accounting scandals to preserve the integrity and effectiveness of audits of public companies. Yet there is still room for improvement, and regulators are considering a number of additional steps designed to improve auditor accountability to investors.

Measures currently under consideration include the following:

  • Require the signature on the audit report of the partner responsible for the audit in addition to the signature of the auditing firm.
  • Require that US audit firms prepare annual reports containing information about their own financial condition and make the reports available to investors.
  • Establish a formal system for monitoring sources of catastrophic risk to audit firms.
  • Morph toward an expanded plain-English audit report.
  • Create a national center for the prevention and detection of financial fraud.
  • Require the appointment of
    independent members to serve on advisory boards to audit firms.

  • Study ways to remove barriers to growth by smaller auditing firms.
  • Set more rigorous standards to address supervision of audit work.
  • Provide investors and other interested parties with more extensive reporting of the activities of the Public Company Accounting Oversight Board (PCAOB), including information about audit firms that fail to remediate deficiencies in their quality control systems.

Importantly for investors, PCAOB board member Steven Harris has said publicly that he believes all these areas should be given serious consideration by the SEC and PCAOB. He also expressed strong support for more participation by investors in discussions about ways to improve audit quality, both at the PCAOB and at the International Forum of Independent Audit Regulators (IFIAR) of which the PCAOB is a member.

For more information, read the Center’s Special Report on Investor Confidence in Audits: What More Can Be Done? This report summarizes the basics of auditing, describes the events and trends that are likely to affect future audits of public companies, and provides links to additional information. It is available at www.fincenter.org/Audit_Integrity.htm.

Add comment August 31st, 2009

Accounting Standards Codification Affects Quarterly Reports

Now that the US Accounting Standards Codification is live and operational, investors in public companies that report under US generally accepted accounting principles (GAAP) can look forward to subtle but important improvements in financial reporting. The Codification could lead to more plain-English explanations and less technical jargon in the notes to the statements starting with quarterly reports for third quarter 2009. Public companies are weighing the merits of a move in that direction now.

The movement toward plain-English disclosures is especially important for US companies and investors. The US differs from other countries in that more half of our population is invested in the stock market, and there is considerable diversity among the users of financial statements. At one end of the spectrum are sophisticated financial analysts and big institutional investors who may be fully conversant with the underlying accounting standards. At the other end are individual investors, some of whom may have a tougher time sorting through the notes and references to related standards. The latter would benefit greatly from the types of plain-English explanations that enhance transparency and understanding.

To help users of financial statements understand the issues, the Center has published a summary of the changes brought by the Codification, the answers to frequently asked questions, and the issues being discussed today by companies and their boards of directors. The complete article is available at http://www.fincenter.org/Accounting_Codification.htm.

Add comment August 22nd, 2009

New Auditor Reporting Requirements Take Effect in December 2009

Investors will soon have more information about the accounting firms that audit public companies, thanks to an order signed by the US Securities and Exchange Commission on August 13, 2009. The SEC’s order officially approves a new set of reporting requirements for all firms registered with the Public Company Accounting Oversight Board (PCAOB).

More Information for Investors

The new auditor reporting requirements include timely disclosures about certain current events, as well as detailed annual reports. These added disclosures are designed to help investors and regulators better assess the risks associated with audit firms and their audit opinions. For example, the list of reportable current events includes the following:

  • An accounting firm withdraws an audit report, and the related issuer has not complied with its requirement to report that event on a Form 8-K.
  • A firm becomes aware than an issuer has made use of the firm’s name in an unauthorized manner without the required consent of the firm.
  • A firm (or any of its partners, managers, or members) becomes a defendant in certain criminal, governmental, administrative or disciplinary proceedings.
  • A firm hires an employee, admits a partner, or contracts to work with a person or entity who is the subject of certain disciplinary sanctions.
  • Any of certain professional licenses or certifications is revoked, suspended or made subject to conditions or contingencies.

These requirements take effect for events occurring on or after October 12, 2009 (60 days after the SEC’s approval). Starting then, the firms will make their reports to the PCAOB, and the PCAOB in turn will make the information available on its website to investors and the general public. Based on this timetable, the first reports on current events could be due to the PCAOB as soon as November 11, 2009 and available to the public shortly thereafter. The first annual reports are due to the PCAOB on June 30, 2010 and will likewise be made available to the public soon thereafter.

More Work for Accounting Firms

Some of the current events reporting requirements were controversial because of the added work they will make for the accounting firms.

One area of added work relates to the communications and controls needed to ensure that current events reports are timely filed. The general rule is that a report for a certain type of event must be filed 30 days from the date the firm becomes aware of certain facts. The firm is considered aware of the facts at the same time that any partner, shareholder, principal, owner of member of the firm becomes aware of the facts. So firms will need to establish procedures to make sure the person responsible for filing the reports is timely notified.

Another area of added work involves the level of documentation needed for those firms that may be able to shield themselves to some extent from the public spotlight in the new regulatory environment. The PCAOB is signaling that it intends to be reasonable, but it doesn’t intend to accept too many excuses or make too many exceptions for firms that fail to provide the appropriate documentation. Examples:

  • Claims of proprietary information. A firm can request that certain categories of information be held confidential. But it will need to support that request with solid documentation, including a representation that the information has not otherwise been publicly disclosed and a detailed explanation of the basis for asserting the information is proprietary or protected by law.
  • Claims of extraterritorial reach. A non-US audit firm may withhold information that it feels cannot be disclosed without violating a non-US law. But the firm will need to provide adequate support for any omissions, including a copy of the local law, a legal opinion, and an explanation of its efforts to obtain the necessary consents or waivers. If the PCAOB feels the support is not adequate, it can use its authority to compel the firm to disclose the information.

The PCAOB has the power to enforce the new requirements under the Sarbanes-Oxley Act of 2002. Under this Act, the Board is, in effect, the auditor of the auditors. It is responsible for registering and inspecting accounting firms that audit public companies whose stock is traded on any US exchange. It also sets applicable auditing standards, and it can conduct investigations of and initiate disciplinary proceedings against registered firms.

The full text of the SEC’s release is available at http://www.sec.gov/rules/pcaob/2009/34-60497.pdf.

Note: The special reporting requirements were originally scheduled to take effect for events occurring on or after October 12, 2009 (60 days after the SEC’s approval) but were subsequently postponed to events occurring on or after December 31, 2009. 

Add comment August 16th, 2009

In Memoriam: Benjamin Neuhausen

Seldom does the world see an accountant with such an engaging leadership style. From FASB fellow to Andersen partner and AcSEC chair, Ben Neuhausen was that rare breed of accountant who could thrive amidst the pressures of the technical side of public accounting. When clients, co-workers, or professional colleagues approached him with questions, they could sense his genuine interest in the issues; and his knowledgeable interactions with them would always leave a lasting impression, no matter what their individual areas of expertise.

Ben lost his courageous battle with cancer last week. His influence in the profession and in our lives will be missed by all, and especially by me. I had the good fortune to meet Ben when he was national accounting director of a major accounting firm. In that role, he became my boss, co-author, confidante, and friend for six years from 2003 through 2009.

In honor of the special role that Ben played in the accounting profession, the Center for Financial and Accounting Literacy has published a memorial tribute that includes a profile of his accomplishments and a summary of his views. The complete article is available at http://www.fincenter.org/Ben_Neuhausen.htm.  

Copyright © 2009 Center for Financial and Accounting Literacy


Add comment August 5th, 2009

Fed Proposes Rules to Protect Borrowers

Directors and investors of companies that originate mortgages or make home equity loans will be interested in rules proposed by the Federal Reserve Board on July 23rd. These proposed rules are designed to protect borrowers against certain kinds of lending practices that may have contributed to the initial stages of the financial crisis.

The Fed’s proposed rules would require lenders to:

  • Provide additional disclosures to mortgage applicants and home-equity loan applicants, including a one-page Q&A document explaining risky features of a loan (such as balloon payments in adjustable-rate mortgages), a revised annual interest rate that includes most fees and costs, and a graph showing borrowers how their rates compare with rates of borrowers with excellent credit.
  • Provide clearer information to loan applicants about costs, including costs of title insurance.
  • Notify borrowers of home-equity loans 45 days before changing the terms of a loan.
  • Prohibit the making of side payments (known as yield-spread premiums) to mortgage brokers or loan officers in exchange for steering borrowers to higher-cost or riskier loans.

Consumer advocates say the proposed rules are long overdue. It has been over two years since Wall Street witnessed the first signs of strains from the subprime crisis. That crisis began in June 2007 when several hedge funds began to report losses related to the subprime mortgage market. Since then, the Fed has undertaken a comprehensive project to review the rules for home-secured credit. The proposed rules would amend Regulation Z, Truth in Lending. They have been exposed to consumer testing and are open for a 120-day comment period.

Notwithstanding the review and field testing, the proposed rules are not a certainty because the Obama Administration has proposed the transfer of the Fed’s authority for consumer protection to a new regulatory agency. But some companies may wish to implement these reforms voluntarily as best practices.

The Fed’s press release and related information is available at www.federalreserve.gov/newsevents/press/bcreg/20090723a.htm.

Copyright © 2009 Center for Financial and Accounting Literacy

Add comment August 2nd, 2009

US Treasury outlines sweeping financial regulatory reforms

Companies and investors who want a glimpse into the nature of future financial regulatory reforms will find a helpful starting point in the US Treasury Department’s white paper on “Financial Regulatory Reform, A New Foundation.” This paper was released in mid-June 2009. The reforms outlined in the paper will have the most direct effects on companies in the financial services industry, but they will also affect directors and shareholders in other industries. The full effects of the changes are still evolving, but the expectation is that they will help investors and consumers avoid unpleasant surprises like those experienced in 2008 and early 2009. Basically, the reforms seek to modernize systems that have not kept pace with decades of financial innovation. These outdated systems resulted in risks that were not apparent to regulators, companies, and investors in the months leading up to the financial crisis, and they forced the government to take extraordinary measures to revive the economy.

There are five key areas for which reforms are being considered:

  • Financial firms. The white paper suggests a series of reforms that are designed to strengthen the foundation for supervision and regulation of financial institutions. These reforms include: (1) establishing a new Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation, (2) granting more authority to the Federal Reserve Board to supervise all firms that could pose a threat to financial stability, and (3) introducing a number of other changes, such as creating a new National Bank Supervisor for all federally chartered banks, eliminating the Office of Thrift Supervision, and empowering the SEC to require registration of advisers of hedge funds and other private pools of capital.  

  • Financial markets. The paper suggests that the regulation of financial markets could be strengthened through added requirements for market transparency, stronger regulation of credit rating agencies, and a requirement that issuers and originators retain a financial interest in securitized loans. Other potential reforms include comprehensive regulation of over-the-counter derivatives (including credit default swaps), and empowerment of the Federal Reserve to oversee payment, clearing, and settlement systems.

  • Investors and consumers. Several reforms are designed to help investors and consumers by promoting simplicity, fairness, and accountability. These include: (1) creation of a new Consumer Financial Protection Agency to protect consumers from unfair, deceptive, and abusive practices, (2) enactment of stronger regulations for consumer and investor products, and (3) a more level playing field and higher standards for ALL providers of consumer financial products and services, regardless of whether they are part of a bank.

  • US government. More tools could be made available to help the government manage any future crises. most notably, a new regime could be established for addressing potential failures of nonbank financial institutions.

  • International cooperation.  Recognizing that financial crises spread quickly around the world, the paper includes a section on raising international regulatory standards and improving international cooperation. The stated objectives are to reach international consensus on how to best improve oversight of global financial markets, enhance crisis management tools, strengthen the capital framework, and coordinate supervision of internationally active firms.

Buried on the final pages of this lengthy document are a few broad recommendations for accounting standards.  Specifically, the paper suggests that the FASB and IASB should strive to do the following by the end of 2009: (1) clarify and make consistent the application of fair value accounting standards, including the impairment of financial instruments, (2) improve accounting for loan loss provisioning, and (3) make substantial progress toward the development of a single set of high-quality global accounting standards. The paper mentions, but does not specifically endorse, the SEC’s proposed roadmap to adoption of IFRS for SEC reporting. The Commission plans to consider the comments received on that proposal.

The financial regulatory reforms outlined in the white paper are complex, and it will likely take time for lawmakers to analyze the effects of the recommendations. Will the need for study hinder the chances of getting these reforms approved in 2009? It is possible that the full package may not be approved. But, clearly, financial regulatory reform is a high priority now while the recent financial crisis is fresh in everyone’s minds, and the Administration will push hard to get at least some of these reforms approved.

The paper is available at http://www.financialstability.gov/docs/regs/FinalReport_web.pdf.


Copyright © 2009 Center for Financial and Accounting Literacy

Add comment July 25th, 2009

SEC proposes changes in proxy rules

The SEC has released the text of its controversial proposed rules on proxy access and disclosures. These rules are designed to help restore investor confidence by providing better information and greater rights for shareholders. Both directors and shareholders should plan to monitor the issues closely because there is a good likelihood of final rules in these areas in time for the 2010 proxy season.

A brief overview:

  • Proxy access. The proposed proxy access rules would allow shareholders to nominate directors (provided the shareholders meet certain ownership requirements), and companies would need to include the names of the candidates nominated by the shareholders in the company’s proxy materials (subject to certain state law prohibitions).
  • Proxy disclosures. The proposed proxy disclosure rules would require that companies make disclosures about the qualifications of directors (both incumbent and nominated) and executives, about how their compensation polices relate to risk, and about any potential conflicts of interest involving compensation consultants.

Pros, Cons, and Prognosis

The main supporters of the proposed rules are corporate governance activists, including labor unions, institutional investors, and pension funds, as well as proxy advisory firms. SEC Chair Mary Schapiro also appears to be a supporter. She has explained that the United States is an outlier in this area. Most other developed countries do permit some level of shareholder proxy access with minimal if any ill effects.

In contrast, the business community has traditionally been opposed to shareholder proxy access. Some feel strongly that this subject should be regulated by the states, rather than a federal agency. But several recent actions appear designed to counter any concerns of this nature:

  1. To avoid any legal challenges based on territorial disputes, Senator Charles Schumer introduced S.1074 on May 19, 2009. The bill is known as the “Shareholder Bill of Rights Act of 2009.” Among other things, this bill would confirm the SEC’s authority to issue a proxy access rule, and it would require that the SEC adopt rules to regulate proxy access (rather than deferring to state law).
  2. The state legislature in Delaware, where many public companies are incorporated, made amendments in April to the applicable state laws so that Delaware corporations will be permitted to adopt the necessary bylaw provisions to accommodate the SEC’s proposed rules.

On balance, the prognosis for passage of a final rule in time for the 2010 proxy seasons appears good, perhaps with some minor changes from the proposed rules. Importantly, these are multi-faceted issues that will require monitoring of not only the SEC’s proposed rules, but also of any expected changes in state and federal laws, and any issues that may be brewing in terms of each company’s unique situation and investor base.

The Bottom Line

Will the rules help or hurt? It seems reasonable to expect that the proxy access rules will be of some help in restoring investor confidence. Even if they are not widely used, they will be seen as a safety net. The value of the proxy disclosure rules is less clear and will likely depend on whether companies respond with meaningful disclosures or boilerplate. Meaningful disclosures will likely take time to prepare, and companies are advised to plan ahead and start now to consider how they would respond to the requirements in the SEC’s proposed rules.

Copyright © 2009 Center for Financial and Accounting Literacy


Add comment July 23rd, 2009

US Treasury Dept drafts “Investor Protection Act of 2009″

The US Treasury Department has introduced a bill designed to strengthen the SEC’s authority to protect investors.

Key provisions would allow the SEC to do the following:

  • Regulate the quality and timing of disclosures. For example, the SEC might require a concise summary prospectus and a simple disclosure showing the costs of a fund prior to the completion of a sale. (Currently these disclosures are typically not made until after a transaction is complete).
  • Establish funding and procedures to pay whistleblowers for information about more types of securities law violations, (provided the information leads to enforcement actions that result in significant financial awards). Currently, these incentives apply only to cases involving insider trading.
  • Pursue more cases involving aiding and abetting of securities fraud.
  • Bar individuals from all aspects of the securities industry, (meaning a person could be barred from becoming either an investment adviser or a broker-dealer because of serious misconduct).
  • Make permanent the recently established Investor Advisory Committee.

The Treasury Department’s press release is available at http://www.ustreas.gov/press/releases/tg205.htm.

Copyright © 2009 Center for Financial and Accounting Literacy




Add comment July 12th, 2009

SEC publishes proposed rules on auditor reporting

Finally, the SEC has published proposed rules on auditor reporting. These rules are one of the reforms required by the Sarbanes-Oxley Act of 2002. Recent events, such as the charges against Madoff’s auditors and life-threatening lawsuits against accounting firms, have emphasized the need for reforms that provide more transparency about audit firms.

If the rule-making action is eventually approved by the SEC, this decision would put into effect a series of rules adopted by the PCAOB a year ago in June 2008. These rules would require that firms registered with the PCAOB file annual reports containing certain required disclosures and that the firms issue special reports when certain events occur.

  • Annual reporting. The annual reports would be required by June 30th of each year for the year ended March 31st of that year. The reports would include information about audits of issuers subject to SEC reporting, such as reports issued in the past year, disciplinary actions and fees.
  • Special reporting. Audit firms would need to file special reports within 30 days after the occurrence of certain events, such as a change in the firm’s name or ownership structure or certain administrative, legal or disciplinary proceedings.

Both the annual and special reports would be made available to the public on the PCAOB’s website, subject to certain exceptions for information for which a firm requests confidential treatment.

At this point, the earliest the requirements could take effect is June 30, 2010. But some firms are already issuing annual reports on a strictly voluntary basis, and additional reforms are possible following recommendations in the final report of the US Treasury Advisory Committee on the Auditing Profession.

The Advisory Committee, also known as the Paulson Committee, suggested that the PCAOB should require the largest audit firms to prepare and privately submit audited financials adhering to Generally Accepted Accounting Principles to the PCAOB by 2011. This would help guide the PCAOB’s decisions about inspections and registrations.  

Comments on the SEC’s proposal are requested by July 20, 2009. The full release is available at http://www.sec.gov/news/testimony/2009/ts060209mls.htm.

Copyright © 2009 Center for Financial and Accounting Literacy




Add comment June 15th, 2009

SEC Chair outlines priorities for 2009

After a year in which trillions of dollars of wealth were destroyed, the SEC is stepping up its efforts to protect investors. Speaking before the Senate Subcommittee on Financial Services and General Government on June 2, 2009, SEC Chairman Mary Schapiro described the specific areas on which the Commission will focus on in 2009:

  • Reinvigorating the SEC’s Enforcement Division. Led by a new Enforcement Director, the SEC staff will be allowed more latitude in the use of subpoenas to obtain documents and testimonies from witnesses.

  • Strengthening risk-based oversight. The Commission is working on a risk-based oversight methodology that will improve its risk-based oversight of brokers-dealers, investment advisers, and mutual funds.

  • Improving transparency. In addition to working with the FASB on improvements in accounting standards, the SEC is focusing on the effectiveness of controls put in place for broker-dealers and investment advisers to prevent the spreading of false information, and additional reforms are expected in 2009 to address investments in municipal securities and harmful pay-to-play practices by investments advisers to public pension funds.

  • Combatting abusive short-selling. Already, the Commission has proposed two approaches to placing restrictions on short sales. These approaches were discussed at a roundtable held in May.

  • Filling regulatory gaps. Some of the areas that might be subject to more regulation include credit default swaps, hedge funds and other unregulated private pools of capital, and differences in the regulations that apply to broker-dealers and investments advisers.

  • Strengthening shareholder rights. Areas of focus include proxy access by shareholders and corporate disclosures that will provide more insights into why a board has chosen a particular leadership structure and how a company’s board of directors manages risks. The Commission will also consider whether more disclosures are needed about executive compensation.

  • Improving money market and mutual fund regulation. The SEC will consider proposals to strengthen to money market fund regulatory regime, to determine whether more regulation is needed over so-called “target date funds,” and whether changes are needed to Rule 12b-1 which permits mutual funds to compensate broker-dealers and other intermediaries for distribution and servicing expenses.

The full speech is available at http://www.sec.gov/news/testimony/2009/ts060209mls.htm.

Copyright © 2009 Center for Financial and Accounting Literacy        




Add comment June 6th, 2009

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