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Audit Plan to Flag Illegal Acts Needs Do-Over, Critics Charge

March 26, 2024

The Public Company Accounting Oversight Board re-opened the comment period under pressure from critics of its 2023 proposal that would overhaul the regulator’s illegal acts standard. Accounting firms, companies, and corporate directors are among those who consider the draft standard a costly expansion of the financial statement audit.

Stakeholders submitted 38 additional comment letters as of their March 18 due date. Many of them called on the PCAOB to submit a fresh draft of the rule for another round of public comments before issuing any final standard.

Under the proposal, auditors would need to consider a wider range of wrongdoing that could alter the financial statements when they vet corporate earnings and balance sheets. Investors have long called for rules that shed more light on legal risks that could sink the value of their shares—from environmental breaches to high-pressure sales tactics.

“Change can be incremental, or moderately paced, without a military coup. The Proposal offers little insight into why the Board is proposing revolution,” wrote Richard Murray, former in-house counsel for Deloitte’s global audit practice and a former chair of the US Chamber of Commerce’s Center for Capital Markets Competitiveness.

Ernst & Young LLP and RSM US LLP urged the board to host more public discussions about how to best narrow the scope of which laws and regulations should warrant auditors’ attention.

The issue was debated at a daylong roundtable held earlier this month—an event overshadowed by the Securities and Exchange Commission’s same-day release of its new rule requiring companies to report on risks stemming from climate change.

“The scope of the proposal is the definitive issue,” the Pennsylvania Institute of CPAs said in its letter to the PCAOB.

The Travelers Companies Inc. joined other commenters asking the board to reconsider the bar for determining whether investors would consider the financial impact to be material. The board should rely on the same materiality threshold used for financial accounting that focuses on what would be important to a reasonable investor, Travelers told the regulator.

The insurer tracked more than 5,000 changes in requirements for its insurance business in the US last year, the company said.

The Society of Corporate Compliance and Ethics and Health Care Compliance Association said the board should allow auditors to rely on internal processes many companies already have in place to track and assess risks stemming from crimes or regulatory violations, rather than asking auditors to duplicate that work.

Deloitte LLP suggested that the board should borrow from similar international audit standards and consider expanding auditors’ risk assessments to include “certain laws and regulations that may have an indirect effect on the financial statement amounts and disclosures such as those fundamental to the operating aspects of the business.”

Fresh Risks
Investors, however, widely support setting a higher bar for auditors, whose work is meant to ensure that corporate financial reporting is reliable, and free from overly rosy assumptions that could mask fraud or market risks that threaten the value of the business.

“There are few issues in the auditing space that are more important to older investors and savers than concerns over fraud,” AARP said in its letter, supporting the board’s efforts to update standards that date to 1988.

The proposal, known as noncompliance with laws and regulations, would replace rules that were largely written by the audit industry, predating modern corporate governance practices and several decades worth of securities law changes, including those that created the PCAOB.

A coalition including Public Citizen, the Sierra Club and 17 other progressive organizations welcomed the PCAOB’s efforts, and called for the auditor review to be broad in scope.

New corporate climate reporting mandates pose fresh opportunities for companies to game their results and “misrepresent” the financial toll that the transition away from fossil fuels could pose for oil companies and other industries, the progressive groups said in a joint letter to the board. Those risks justify the board’s proposal but the regulator could go further to ensure that auditors carefully vet how climate commitments and decarbonization could alter assumptions that shape asset values or trigger writedowns.

“An audit that does not consider emerging climate-related regulation and growing social and environmental litigation risk misunderstands the actual financial position of and risks to a company,” the groups said in the joint letter.

Board staff will consider the latest feedback on the project as they draft possible revisions. The project is currently slated to be finalized later this year.


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