If you're like us, you've been anxiously awaiting comment letters on the PCAOB's auditor reporting model proposal. There's nothing better than self-righteous firms penning letters filled with thinly-veiled condescension. Plus, the U.S. Chamber owes us all an honest effort after phoning in their initial response.
So far none of the major accounting firms, the AICPA, CAQ, Chamber or other heavy hitters have their comments posted on the PCAOB's website. We're on the look out but in the meantime, there is an extensive joint letter from the National Asian American Coalition and African Methodist Episcopal Church.
Yeah, I don't know, but hey, it's something.
The letter sides strongly with Board member Steven Harris, who expressed quite a bit of disappointment with the proposal, stating:
We would urge that the Board take seriously all of Board Member Harris’ perceptiveobservationsabouttheinfirmitiesandweaknessesoftheproposedchanges.
One of the biggest problems that Harris has spoken about over the years is the issuer-pay model. That is, the companies that are required to obtain an independent audit pay the auditors who perform the independent audit.
This arrangement defies comprehension. Yet at some point, some supposedly smart people concluded that this arrangement was perfectly fine and that the audit business would attract individuals who were impervious to the temptation of pleasing clients that were giving you millions of dollars for your services. "Oh, you want to pay us to independent? Right away, sir!"
Even the NAAC and AME Church who, at best, have a marginal interest in this topic, know that expecting audit firms to be independent is like expecting a dog not to eat a plate of bacon you left on the counter:
[W]e strongly urgean historic change from the pastas to howauditors should bepaid.Ratherthanbeingpaidbythecorporationtheyaudit,allpaymentsshouldcomefromacentral PCAOB-controlled fund. This would enable the auditors to be totally free ofcorporateinfluence,atleastasitaffectsthelevelofcompensationforservices.Weestimatethat this PCAOB central fund would be approximately $2.5 billion just for Fortune 500corporationswhowouldcontribute to the fundbasedupon thecomplexityandsizeoftheaudit.
WebelievethatmanylargeCPAfirmswouldpreferthisifthegenerallevelofcompensationtothemwasfairandrelatedtothesizeandcomplexityof theaudit.Pleasenote,wedonotcontend that present compensation is excessive. We are merely trying to maximize theindependenceofandperceptionsofindependencefrommanagement.
A PCAOB central fund probably isn't politically plausible and like most things in the accounting world, disrupting the status quo is always a non-starter.
Unless more stakeholders start asking for a solution that doesn't involve issuers lining auditors' pockets, independence will remain nothing more than lip service.
Remember Alterra Capital Holdings Ltd? They’re were exposed by Bloomberg’s Jonathan Weil last month as the KPMG-Bermuda audit client that was selected by the PCAOB for inspection. The audit didn’t go so hot as the inspectors found “the firm did not obtain sufficient competent evidential matter to support its opinion on the issuer’s financial statements.” To put this in context, Weil explained that available-for-sale securities were the largest asset on Alterra’s balance sheet and it accounted for “half of the company’s $7.3 billion of total assets as of Dec. 31, 2008, and a little more than half of its $9.9 billion of total assets at the end of last year.”
In wake of this little revelation, research firm Glass Lewis & Co. has recommended to Alterra Capital Holdings that they kick KPMG-Bermuda to curb (after nine glorious years), according to a copy of the “Proxy Paper” sent to Going Concern. The report rehashes the whole story and then concludes with this:
Despite the lack of any restatements of previous financial statements, we believe that shareholders should be concerned about the reappointment of KPMG following the lapses uncovered by the PCAOB. Therefore, we believe that shareholders should hold the audit committee responsible for reappointing the same audit firm.
Glass Lewis also wanted to make shareholders “aware” of the fact that Alterra’s Audit Committee Chair, CFO and CAO are all KPMG alumni but stopped short of citing it as a reason to oppose KPMG at the meeting on May 2. According to the report, Glass Lewis had recommended that Alterra retain KPMG as auditor prior to the last shareholder’s meeting which the shareholders did by an overwhelming margin with nearly 91 million votes voting “For,” 182k voting “Against” and 32k abstained.
~Update 2 includes statement from Claudius Modesti, PCAOB Director of Enforcement and Investigations
Today in obscure accounting oversight board enforcement actions, an Ernst & Young Manager in the Boston office was censured by the PCAOB for repeated violations o y to Cooperate with Inspectors, and Auditing Standard No. 3 (“AS3”), Audit Documentation.
The violations occurred when 27 year-old Jacqueline Higgins “(1) added documents to the working papers without indicating the dates that documents were added to the working papers, the names of the persons preparing the additional documentation, and the reason for adding the documentation months after the documentation completion date; and (2) removed a document from the working
papers after the documentation completion date.”
The timeline goes like this: E&Y was given notice by the PCAOB that an inspection of the unknown company’s audit was being performed on March 30, 2010 and the partner, senior manager and manager on the engagement were given notice on March 31, 2010. The inspection fieldwork was set to begin on April 19, 2010.
On April 5th, the three Ernsters began preparing for the inspection and that’s when problems started cropping up which led to more trouble. The order has the details:
First, Respondent reported to the Engagement Partner and the Senior Manager that a “Review Procedures Memorandum” was missing from the external working papers. The Engagement Partner and the Senior Manager directed Respondent to create and print out the missing document, and to backdate the document to November 30, 2009. The Engagement Partner and the Senior Manager directed Respondent to backdate her sign-off on this working paper to November 30, 2009, and to add this document to the external working papers.
17. Second, Respondent reported to the Engagement Partner that the tie-out of the financial statements contained in the external working papers was performed upon a pre-final set of financial statements. The Engagement Partner directed Respondent to remove this document from the external working papers, and to replace it with a newly created document which tied-out the final financial statements, and which the Engagement Partner directed Respondent to backdate to November 2009.
18. Third, Respondent reported to the Engagement Partner that the Average Forward Foreign Currency Contracts Calculation (“A3a Working Paper”) was missing from the external working papers. The Engagement Partner directed Respondent to gather the missing document, backdate it to November 2009, and add it to the external working papers.
19. Finally, Respondent reported to the Senior Manager that three checklists were missing from the external working papers. The Senior Manager directed Respondent to assemble the missing checklists as a single document (“HH6.8 Working Paper”) and to backdate her sign-off on this working paper to November 2009. The Senior Manager directed Respondent to add the document to the external working papers. The Senior Manager and Respondent reported to the Engagement Partner the facts and circumstances related to the creation of the HH6.8 Working Paper, and the Engagement Partner took no steps to cause the document to be properly dated, or to have it removed from the external working papers.
So those are the wonky details. Where this particular story is most interesting (in our opinion) is that Ms Higgins was, prior to this little mishap, on the fast track. According to the order, she graduated in May of 2005 and started with E&Y in September. She was promoted to senior associate in October of 2007 and then promoted to manager in October of 2009. Now, perhaps she was an audit-savant or perhaps not but in just over four years, she was a manager, which is a much quicker pace than usual.
Granted, she was still under the supervision of the senior manager and partner on the engagement but a young manager nevertheless. Now, you might be asking yourself, “what about the senior manager and partner? Are they getting their wrists slapped?” Conventional wisdom tell us, “absofuckinglutely” but the PCAOB isn’t saying. We were told by a spokesperson that the Board cannot comment on any other action related to this case.
As far as what a censure by the PCAOB actually entails, we were told that “It is an official reprimand from the PCAOB.” Some might call it a wrist slap but we’re damn sure you don’t want that in your file when you’re 27 years old. The action also states that Ms. Higgins was removed from the engagement in July 2010 and “at that time Higgins ceased participating in issuer audit engagements.”
Messages with E&Y spokesperson Charles Perkins and A message left with an attorney for Ms. Higgins were not immediately returned.
Ernst & Young has issued the following statement:
Our firm policy clearly prohibits persons from supplementing audit workpapers in circumstances like those described in the disciplinary order. When we determined that firm policy had been violated, we put the three individuals involved on administrative leave and subsequently separated the partner and senior manager. We have advised the PCAOB of these facts and have cooperated fully with the PCAOB throughout its investigation of this matter.
Based on the above, you might conclude that more disciplinary action will be coming from the PCAOB but like we said, they’re not talking.
UPDATE 2 – circa 3:30 pm: Claudius Modesti, PCAOB Director of Enforcement and Investigations, explained the seemingly light punishment in an email to Going Concern:
As to the censure, under the facts and circumstances, the censure is appropriate given Higgins’ relatively junior position on the audit team and her overall role in the conduct. We also considered the fact that she settled the matter without requiring the Board to commence litigation, which would have been nonpublic as required by the Sarbanes-Oxley Act.”
It was then explained to us that the PCAOB has never explained a disciplinary action in this way: “We also considered the fact that she settled the matter without requiring the Board to commence litigation, which would have been nonpublic as required by the Sarbanes-Oxley Act.”
If that’s not quite clear, consider this: It is significant because, had Ms Higgins acted in the alternative (i.e. not settled), litigation would have been necessary and no one outside of the PCAOB, Higgins, her lawyers and E&Y would have known about the proceedings. Granted, it’s fairly common for lighter disciplinary action to result from a settlement but it also makes sense from a PR perspective (not to mention, transparency and investor protection) if the PCAOB can actually announce that they are taking action against people who break the rules. Part of the challenge the Board has faced is convincing anyone that they have teeth.
It will be interesting now to see if the senior manager and partner follow the same track as Ms. Higgins and how the PCAOB will respond to their cooperation (or lack thereof).