Demolishing PCAOB Would Increase Risks of Fraud, Investor Harm

Congress created the Public Company Accounting Oversight Board in 2002 to protect investors after auditor malfeasance was at least partly responsible for two of the largest frauds and corporate bankruptcies in US history. The board was structured to be self-funded as a quasi-independent body apart from the Securities and Exchange Commission, meaning no taxpayer dollars are required for its operation.

If the Republican budget reconciliation bill H. Con. Res. 14 is enacted, this design will vanish and the PCAOB’s ability to catch and penalize bad auditors, inspect foreign audit firms, and share information with foreign regulatory partners will be curtailed or eliminated. Congress should be strengthening the PCAOB—not handcuffing it—as artificial intelligence, cybersecurity threats, staffing shortages, and investor pressures present ever-increasing risks.

The PCAOB is quasi-independent because while it is self-funded, its budget and standard-setting activities require SEC approval. This self-funding structure allows the board to pay competitive salaries above government pay scales and equal to what staff and counsel at the board would be able to secure in the private sector.

This allows the board to hire experienced and proficient staff to inspect audit firms and take enforcement actions against auditors who fail to meet its standards.

Rolling the PCAOB up under the SEC would end this competitive advantage. It would subject board staff to lower government pay structures and force the PCAOB to compete with other SEC priorities.

This would stretch its limited resources more thinly and reduce its ability to inspect as many firms and engagements as necessary. The change would lead to fewer and less experienced audit inspectors and lawyers and more underperforming audit firms going undetected—increasing the risk of more sham audits, undetected frauds, and harm to investors.

The Senate Banking Committee proposal addressing the PCAOB is even more extreme and foreboding for investors. It would bar the SEC from raising revenue from transaction fees, its main funding source, to pay for staff and the boards oversight, effectively killing the board’s ability to function by starving it of resources.

If the SEC then chose to not allocate any fund to the board, the board couldn’t obtain funds as Congress previously authorized it to. It would continue to exist in name only.

It also would threaten cooperation with foreign governments and regulators that took the PCAOB its entire existence to negotiate inspection agreements with. PCAOB inspectors didn’t gain access to Chinese auditors of US-listed firms until 2022. And Germany’s audit regulator has said the proposal would threaten the PCAOB’s independence and could lead to the regulator no longer cooperating with it.

Foreign governments are hesitant to turn over data on their own firms and companies to US agencies subject to direct political influence. It makes sense; our own government is similarly hesitant.

That is why the PCAOB’s quasi-independence is its biggest asset. It gives the board access it wouldn’t have as a department within the SEC—access to foreign firms, the most qualified staff, and funding to operate as the watchdog Congress designed it to be in the Sarbanes-Oxley Act.

The PCAOB isn’t without fault or criticism. Its standard-setting activities are often too slow and deliberative. Only recently did it update the confirmation standard to allow the use of email and other modern forms of communication on an audit despite their prevalence at firms for decades.

It is also true that adhering to some of the standards is costly and laborious for smaller firms with few SEC registrants. Further, the board’s inspection processes and subsequent enforcement actions sometimes focus on less critical audit lapses or low risk areas when no deficiencies were found in higher risk or critical audit areas.

However, much of the criticism comes from the same firms subject to PCAOB fees, inspections, fines from enforcement actions, and auditing standards. Firms don’t like paying to be inspected in the same way corporations don’t like paying to be audited. But both are necessary.

The PCAOB’s shortcomings are fixable with the board structured as Congress intended after the Sarbanes-Oxley Act. Destroying the structure in response to criticism is akin to knocking your house down because you don’t like the wallpaper. The PCAOB needs reform, not demolition.

The Republican proposal is all risk and no reward for investors; it only would benefit audit firms not adhering to PCAOB standards. Effectively dismantling the board would help bogus audit firms such as BF Borgers go undetected, make more foreign auditors of US-listed companies immune to inspections, and grind the standard-setting process to a halt. It would make the rise of the next Enron, WorldCom, or FTX more likely.

Discussing PCAOB reform is warranted in Congress, by the public, and within the board. Removing its independence, access, and funding structure shouldn’t be part of that debate.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Jack Castonguay is a CPA, associate professor of accounting at Hofstra University, and vice president of content development at KnowFully Learning Group.

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