PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD

The Sarbanes-Oxley Act of 2002 began with this statement of purpose: to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes. As stated in the act:

There is established the Public Company Accounting Oversight Board (PCAOB), to oversee the audit of public companies that are subject to the securities laws, and related matters, in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports for companies the securities of which are sold to, and held by and for, public investors. The Board shall be a body corporate, operate as a nonprofit corporation, and have succession until dissolved by an Act of Congress. (Sec. 101)

The board provides a structure that is a marked departure from the earlier regulatory structure. Previously, the Securities and Exchange Commission (SEC) had delegated a considerable degree of rule making and oversight to the public accounting profession. Nevertheless, with the initial decisions of the PCAOB in the spring of 2003, rule making for auditing and oversight of auditors and their firms became fully the responsibility of the PCAOB itself.

BOARD MEMBERSHIP

As stated in the act, the board has five members, "appointed from among prominent individuals of integrity and reputation who have a demonstrated commitment to the interests of investors and the public." Furthermore, the members are expected to be knowledgeable of the nature of financial disclosures required of issuers under the securities laws and of the obligations of those who undertake audits of such issuers and issue reports.

Two members, and only two members, are to be certified public accountants (CPAs) or have been CPAs previously. If one of the two members is the chairperson of the board, he or she "may not have been a practicing certified public accountant for at least five years prior to his or her appointment to the Board." Members serve on a full-time basis and may not engage in any other business or professional activity during their service as board members.

Members are appointed for terms of five years and no member may serve for more than two terms, whether or not the terms of service are consecutive.

BOARD DUTIES

The act specifies the duties of board members with responsibility to:

1. Register public accounting firms that prepare audit reports for issuers
2. Establish or adopt, or both, by rule, auditing, quality control, ethics, independence and other standards relating to the preparation of audit reports for issuers
3. Conduct inspections of registered public accounting firms
4. Conduct investigations and disciplinary proceedings concerning, and impose appropriate sanctions where justified upon registered public accounting firms and associated persons of such firms
5. Perform such other duties or functions as the board (or the SEC by rule or order) determines are necessary or appropriate to promote high professional standards among and improve the quality of audit services offered by registered public accounting firms and associated persons thereof, or otherwise to carry out this act, in order to protect investors, or to further the public interest
6. Enforce compliance with this act, the rules of the board, professional standards, and the securities laws relating to the preparation of audit reports and the obligations and liabilities of accountants with respect thereto by registered public accounting firms and associated persons
7. Set the budget and manage the operation of the board and the staff of the board

For the first four duties listed above, there are references to specific sections of the act.

OFFICES AND STAFF

The PCAOB's headquarters are in Washington, D.C. Regional offices in 2005 were in eight locations: Atlanta, Chicago, Dallas, Denver, New York, Northern Virginia, Orange County (California), and San Francisco. The total number of staff at the end of 2004 was 260.

Among the key executives of the staff are the chief of staff, chief accountant, the director of enforcement and inspections, the director of registration and inspections, and director of government operations.

THE IMPACT ON PUBLIC ACCOUNTING

As noted by the American Institute of Certified Public Accountants (AICPA) in a discussion of the impact on the field of accounting, "the relationship between accounting firms and their publicly owned audit clients is different under the new law."

Possibly the most dramatic shift is that professional involvement of practitioners in rule making and monitoring is no longer provided. While earlier auditing standards for publicly owned companies were promulgated by the AICPA's Auditing Standards Board, such standards are now the responsibility of the PCAOB. The SEC continues to have ultimate responsibility and must approve the decisions of the PCAOB. The AICPA's Auditing Standards Board continues to function in developing guidance for nonpublicly owned companies. The inspection of public accounting firms is no longer designed and administered by the member-sponsored organizations.

Auditors now report and are overseen by a company's audit committee, not management. Audit committees must approve all services to be provided by the audit firm. Specified new information must be reported to audit committees. All rules related to independence and quality control are now provided by the PCAOB.

UNRESOLVED ISSUES

The PCAOB has been functioning since the spring of 2003. Much of the guidance provided by the Auditing Standards Board of the AICPA was accepted as interim guidance as the PCAOB reviews the auditing standards and makes determinations about what is to be accepted, what requires revision, and what requires new auditing standards.

As noted earlier, the Auditing Standards Board of the AICPA continues to function to provide guidance for audits of those entities that are not required to report to the SEC under the specifications of the Securities Exchange Act of 1934 in accordance with auditing guidance from the PCAOB. Inasmuch as auditing is a generic process, many critics have raised questions about the wisdom—and complexity—of two sets of standards, as many public accounting firms serve both types of clients.

The new requirement for an audit of internal controls led to much criticism. Section 404 of the act and rules adopted by the SEC require companies that file annual reports with the SEC to report on management's responsibilities to establish and maintain adequate internal control over the company's financial reporting process, as well as management's assessment of the effectiveness of internal controls. Section 404 requires the accounting firm that audits the company's financial statements to perform an audit on management's assessment and on the effectiveness of the company's controls.

Questions have been raised about the value of such an audit related to internal control and the burden imposed by additional costs. Furthermore, there are critics who believe that the scandals related to accounting during the early years of the new century would likely not have been averted by an audit of internal control. Enron, in its 2001 annual report, included an audit report from its audit firm, Arthur Andersen, about its internal controls. (Arthur Andersen had served as the company's internal auditors; thus, they were auditing their own work, which is a violation of the independence required of public accountants at the time.)

This requirement for an audit of internal controls and the submission of an auditor's report became effective with annual reports for fiscal years ending after December 15, 2004. The cascade of questions about the need for the requirement, the nature of the requirement, and the guidance provided led the SEC to convene a Roundtable on Implementation of Sarbanes-Oxley Internal Control Provisions for April 13, 2005. Over 200 letters of comment were submitted to the SEC related to this new requirement. The Roundtable was open to the public. Follow-up of the Roundtable included the provision of additional guidance. Challenges to the value of such an audit continue.

WEBSITES OF INTEREST

For extensive information on activities and plans of the PCAOB: http://www.pcaob.org

The AICPA also provides information about developments at the PCAOB: http://www.aicpa.org

see also Accounting

Bernard H. Newman