CORPORATE CRIME REPORTER
Public
Interest Groups Say PCAOB’s Proposed Audit Standard Poses Profound Threat
to Investors
21 Corporate Crime Reporter 10, February 27, 2007
Three public interest groups said yesterday that the Public Company Accounting
Oversight Board’s (PCAOB) proposal to scrap its current auditing standard
and replace with a lite version poses a “profound threat to investors.”
Late last year, the PCAOB, under pressure from the business community, proposed a 65-page auditing standard to replace the existing 180-page standard.
Thomas Ray, the PCAOB’s chief auditor, said the new standard would “allow auditors to focus more clearly on what is more important.”
But in comments submitted to the PCAOB yesterday, representatives of the Consumer Federation of America, Consumer Action, and the U.S. Public Interest Research Group said that while the PCAOB rejected a number of alternative auditing standards that would have “eviscerated the control audit as a deterrent to fraud and as a means of preventing financial statement error,” its current proposal is a “top-down, risk-based approach to the internal controls audit without in any way addressing the short-comings that have made that approach such an abysmal failure in the audits of financial statements.”
“Until the Board analyzes the many failed risk-based financial statement audits and determines what went wrong, it cannot in good conscience propose a risk-based approach to the internal control audit with any confidence that it will provide an appropriate level of investor protection,” the groups wrote. “The Board sends the strong message throughout this proposal that reducing costs is more important than improving, or even maintaining, the effectiveness of these audits. This not only results in serious weaknesses in the standard itself, it suggests that the Board will not provide the strong regulatory and enforcement backing needed to make a principles-based approach effective.”
The groups said that the PCAOB’s rewrite of the existing auditing standard was “unwarranted” and was “driven more by political expediency than by any evidence either that the costs of the rule exceed its benefits or that its costs, where excessive, could not be reduced through other, less radical means.”
“Certainly, the Board has produced no cost-benefit analysis justifying its actions,” the groups wrote.
The groups called on the PCAOB to resist the political pressure being generated by the business community, “assert its independence, and withdraw its ill-founded, ill-advised rewrite of the standard.”
“Not only would that benefit investors directly, by ensuring that internal control requirements continue to work to improve the quality of financial disclosures, it would also benefit investors indirectly, by sending the message that the Board cannot be bullied by a business community intent on achieving cost savings at the expense of investor protections,” they wrote.
In their letter, the groups chastised the PCAOB for apparently making no effort to “determine what are the root causes behind the numerous recent massive failures of risk-based financial statement audits, let alone feed those results back into their audit standards.”
“Yet, this would seem to be a minimum first step before proposing a major expansion of the risk-based approach,” the groups wrote. “Not only does the current proposal reflect no effort to address weaknesses in the risk-based audit approach, it actually takes steps that are likely to exacerbate those problems. Of greatest concern in this regard is the expanded reliance on the work of others it allows without imposing appropriate limitations.”
The groups also called on the PCAOB to correct the proposed standard’s “anti-investor” tone.
They cited “numerous examples” throughout the proposed standard where the language used sends “the subtle and not-so-subtle message that a key concern of the auditor should be to reduce the costs of the audit, even at the expense of its effectiveness.”
The groups cited a note in the proposed standard that reads:
“The auditor should select for testing only those controls that are important to the auditor’s conclusion about whether the company’s controls sufficiently address the assessed risk of misstatement to a given relevant assertion that could result in a material misstatement to the company’s financial statements.”
“A pro-investor rewrite would state that the auditor should select for testing all those controls that are important to the auditor’s conclusion,” the groups wrote. “These differences in language matter. As written, the proposed standard sends the strong message that auditors may be asked to justify any decision to test controls that someone later deems were unimportant. As a result, it risks encouraging auditors to under-test – the very weakness that has been identified as central to the failure of risk-based audits of the financial statements. The pro-investor alternative sends the opposite message, that auditors may be asked to justify a failure to test controls that are later deemed to have been important. Some would argue that this statement risks encouraging auditors to overtest, though experience based on the pressure audit clients are able to bring to bear on auditors suggests this concern is exaggerated. A neutral statement would simply state that the auditor should select for testing those controls that are important to the auditor’s conclusion.”
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