SEC Signals Shift in Audit Oversight, Potentially Reducing Inspections of Big Four Firms
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A significant change in how the securities and Exchange Commission (SEC) oversees accounting firms might potentially be on the horizon, with regulators indicating a willingness to reduce the number of individual audits inspected. This potential shift comes amid lobbying efforts aimed at reforming a regulatory regime some argue focuses excessively on minor infractions.
The SEC’s move signals a potential recalibration of audit oversight two decades after the Enron scandal prompted increased scrutiny of the accounting industry. According to a senior official, the current inspection process, while improving audit quality, has reached a point where its effectiveness can be enhanced by focusing on systemic issues rather than individual audit details.
PCAOB Inspections Under Scrutiny
The Public Company Accounting Oversight Board (PCAOB), the body responsible for overseeing audits of U.S. public companies,has steadily increased the number of audits it examines annually. In the past year, the PCAOB reviewed 63 or 64 audits conducted by the “Big Four” accounting firms – EY, KPMG, Deloitte, and PwC – a rise from the 53 or 54 audits inspected two years prior.
While the PCAOB has presented the deficiency rate as a key indicator of audit quality, the rate experienced a surge following the COVID-19 pandemic before beginning a recent decline. Audit firms have privately expressed concerns that the increase in deficiencies was partly attributable to inspectors identifying minor errors that previously wouldn’t have triggered penalties.
A Focus on Systemic Quality Control
The proposed shift in focus comes as international regulators develop more detailed rules governing how accounting firms manage their businesses, including enhanced oversight and quality control measures. The PCAOB itself approved new rules last year regarding audit quality monitoring, though implementation has been delayed and is subject to potential revision.
“Focusing inspections on quality control systems rather than individual audits would shift accountability to the leadership of the firm and their systems and processes, and less on individual engagement teams,” explained Kurt Hohl, the SEC’s chief accountant, at a recent industry conference. He also acknowledged the “stress” placed on audit teams during inspections.
Industry Response and Potential Impact
Industry representatives anticipate a reduction in the number of individual audits selected for assessment.”If audit quality is higher today than it was 20 years ago, than maybe there’s fewer individual engagements that need to be selected,” stated Dennis McGowan, vice-president for professional practice at the Center for Audit Quality, which represents large accounting firms.
However, george Botic, the acting PCAOB chair, cautioned against a drastic overhaul, emphasizing the need for careful consideration and input from investors and other stakeholders. He noted that while the Sarbanes-Oxley Act mandates inspections, it doesn’t specify a minimum number.Botic also warned that reducing the transparency of inspection findings coudl damage the PCAOB’s reputation and erode trust in the capital markets. Currently,only individual audit inspection results are public; findings related to a firm’s quality management system are published only if remediation efforts fail within a year.
Debate Over Inspection Levels
PCAOB board member Christina Ho, who has previously aligned with accounting firms’ positions, anticipates a decrease in the number of audit inspections under the new SEC regime. She suggested that staffing levels for inspections “could and should be cut more,” as stated at a PCAOB meeting on December 19.
The debate highlights the tension between ensuring rigorous audit quality and minimizing the burden on accounting firms. Individual audit inspections will remain a crucial component of verifying the effectiveness of quality management systems, according to Botic. “There’s a certain number of files that one has to do,” he said, adding that any significant reduction in inspections would require extensive consultation.
The SEC’s potential policy shift represents a significant moment for the accounting industry,with the long-term implications for audit quality and investor confidence yet to be fully understood.
