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FT editor Roula Khalaf selects her favourite stories in this weekly newsletter.
Gone are the days when company bosses could dismiss their non-executive directors as mere “baubles on the Christmas tree”, as the maverick British businessman Tiny Rowland did in the 1980s. After several rounds of corporate governance reforms, independent directors are not just decorative elements, but actually a crucial pillar of our trust in public markets.
The heads of American auditing firms, which play an equally important role in the integrity of the capital markets by auditing company financial statements, are apparently more skeptical about the formalization of external supervision in the regulatory area.
A new rule passed by the U.S. Public Company Accounting Oversight Board (PCAOB) will force each of the largest companies to set up a quality control oversight board and ensure that at least one person on the board comes from outside the company. The rule is part of a broader overhaul of quality control standards that the industry itself set decades ago and that are only now being updated by the PCAOB, some 20 years after the agency was created following the Enron scandal.
Several large firms, including PwC and BDO, are making a last-minute bid to defeat the rule. The move has raised eyebrows among some investor groups, who point out that many firms already boast of having boards that sound very similar to the proposed rules.
In June, BDO announced it had hired a second external member for its “Audit Quality Advisory Council” to provide “input” to its audit quality system as the firm tries to improve its worst-rated PCAOB inspection scores. PwC has even asked global regulators to facilitate the hiring of more external members for its advisory groups and boards, the Financial Times reported in December, saying they would help make discussions “less siloed.”
But these six major accounting firms, along with the industry association, have petitioned the Securities and Exchange Commission (SEC) to overturn the rule. The Chamber of Commerce also warned that the rule would be “legally at risk” if the SEC did not conduct an independent cost-benefit analysis. The SEC must approve all PCAOB standards before they can go into effect. Although it has never overruled the audit watchdog before, the furore has prompted it to delay approval.
The PCAOB countered this month with a 28-page defense of the standard, urging the SEC to approve it and at some points barely concealing its irritation. “Some firms have already chosen to incorporate elements of independent oversight into their corporate governance structures, and the existence and diversity of these roles demonstrates that implementation of this … requirement is feasible rather than unrealistic,” it said.
The specific language of the rule requires companies to report to their oversight boards on the effectiveness of their quality control system, and the oversight board is supposed to evaluate in that report “the significant decisions made and the company’s related conclusions.” The PCAOB referred to this as a “baseline.”
By turning voluntary advisory boards into mandatory oversight roles, the PCAOB is explicitly increasing the requirements for outside members, meaning they must earn more and carry professional liability insurance. Some opponents of the SEC petition say the additional layer of oversight is not worth it.
But the majority argues only that the PCAOB has not done enough to define exactly how the new oversight function should work. The PCAOB has found more auditing standards violations and imposed higher fines on auditors under Biden administration-appointed Chair Erica Williams. Companies fear the agency’s inspectors will scrutinize the work of the new oversight bodies, looking for paperwork violations and other loophole opportunities. The financial stakes are higher and trust lower than in the past.
In other circumstances, this problem should be solvable by written guidance from the agency prior to the entry into force of the rule and a review after implementation if there is evidence that adjustment is necessary.
But the industry isn’t willing to give in. As the PCAOB works to update decades-old standards, more significant changes are coming, including a new rule that will force companies to take more responsibility for detecting fraud and violations in the companies they audit. Some see this as an opportunity to remind the PCAOB that it needs to dot every i and cross every t.
Williams likes to say that her PCAOB uses “every tool in our toolbox” to hold accounting firms accountable. Now she’s finding that firms are using every tool in their toolbox to slow her down.
