PCAOB Member Uncorks on Agenda

One of the five members of the Public Company Accounting Oversight Board blasted his own agency on Wednesday, saying that the regulator’s plans for the next 12 to 18 months are “a tragic mistake” that ignore the needs of investors and undermine the credibility of corporate financial reporting.

The statement came from PCAOB board member Robert Brown, in response to updated research and standard-setting agendas that the PCAOB released last month. Gone, he said, are priorities that investors have repeatedly identified as important, such as how to handle non-GAAP financial metrics and what an audit firm should do when it encounters a client’s non-compliance with laws or regulations. 

What remains on the agenda, he said, are objectives that largely align with the priorities of international audit regulators. While the convergence of auditing standards is a nice idea in theory, “the goal of global alignment and coordination should not take precedence over the expressed interests of U.S. investors,” Brown said.

He also complained that the PCAOB removed those items from its agenda without any input from investors. The new agendas published last month simply dropped the subjects, no explanation given.

“There have been no public meetings of our advisory groups to discuss these changes or any other standard-setting matters,” Brown wrote in his statement. “Rather than reflecting the interests of investors, the revised agendas remove the very matters that investors have repeatedly identified as important.”

In the genteel world of PCAOB auditing standards, you rarely see criticism so pointed. In my observation it usually means a PCAOB board member is about to leave his or her position; I have no idea whether that’s the case here. Brown joined the PCAOB in 2018 and his term is scheduled to expire in one year. He’ll also be eligible to serve a second term if the SEC leaders want to reappoint him.

Regardless, this is a “holy cow!” moment in PCAOB circles. 

Brown’s Bones of Contention

Brown flagged three specific issues that were dropped from the PCAOB agenda:

The auditor’s role in non-GAAP metrics. Almost every large company now reports at least one financial metric that isn’t part of U.S. Generally Accepted Accounting Principles. That’s not necessarily wrong, but it raises interesting questions. For example, how much should investors rely on non-GAAP metrics if audit firms aren’t auditing those numbers? More broadly — if everyone is using non-GAAP does that imply that current GAAP isn’t sufficient for investor needs? 

The auditing standard for non-GAAP, however, hasn’t been updated since 1978, when the Bee Gees were at the top of the charts. Brown’s take: “The role of assurance for these matters has been a topic of global discussion, goes directly to the relevance of the role of the auditor, has increasingly been seen as relevant in the debate on the impact of climate change on financial disclosure, and has only grown in importance as a result of the current pandemic.”

Auditor’s consideration of noncompliance with laws and regulations. Auditors do have certain duties to report illegal acts by their clients, but that standard was adopted in 1988 and hasn’t changed much since — while the rest of the world has implemented enormous corporate compliance apparatus, including the nearly universal adoption of whistleblower hotlines. Moreover, most corporate misconduct now revolves around improper operations, rather than improper accounting fraud. So what should an audit firm do when it encounters the former, rather than the latter? 

An entity’s ability to continue as a going concern. Auditors have long been obligated to assess whether there is substantial doubt about a client’s ability to continue operating for the coming 12 months. Two things have changed recently. First, since 2017, management has also been obligated to perform (and disclose) its own going-concern assessment. 

More urgently, the pandemic has demonstrated to us all — and sometimes painfully so — that a firm’s ability to continue as a going concern involves much more than the firm’s own operations. For example, what good are ample cash reserves and solid remote work policies, if your customer base has evaporated? (A problem facing the AMC Entertainment Corp. theater empire right now.) As Brown said, “The impact of the COVID-19 pandemic… has reconfirmed the importance of this area and the need to ensure that requirements under the standard are sufficient to ensure proper treatment and disclosure by auditors.”

What Next for PCAOB?

Honestly, I don’t know. One might assume that the next PCAOB open meeting should be quite the spectacle — except, Brown complained about the agency on that front, too:

The PCAOB faces a serious transparency problem. Other than the meetings of our advisory groups, we rarely hold roundtables or other public meetings designed to debate, discuss, and obtain feedback on matters of importance to the PCAOB’s mission. Lack of transparency was a concern in the era of self-regulation, and has yet to be fully remedied. Without adequate transparency, there cannot be adequate accountability.

The PCAOB’s two advisory groups, he went on to say, haven’t met in nearly two years. Which means they haven’t had any chance to evaluate the PCAOB’s newly revised agenda — the one that just cut all the issues those same advisory groups had said were important. So that’s awkward. 

Then again, I also can’t help but wonder: Is Brown laying down markers for a post-Trump PCAOB?

Today’s prime fact is that President Trump is likely to lose re-election. That would mean new leadership at the PCAOB and the Securities and Exchange Commission (which appoints PCAOB members), within a matter of months. 

We can already see awareness of that fact in recent SEC rulemaking: chairman Jay Clayton and his Republican colleagues are ramming through one GOP agenda item after another, even if those rules push against the limit of what cost-benefit analysis or the letter of the statute suggest. The PCAOB suddenly inverting its own standard-setting agenda seems along those same lines. 

So if a Biden Administration comes to power in 14 weeks, will this new agenda go into the deep freeze? Will Brown’s wish list get back onto the list? 

As a certain president likes to say, we’ll see.