In January 2012, as the ten-year anniversary of the creation of the Public Company Accounting Oversight Board (the ―PCAOB‖ or ―Board‖) under the Sarbanes-Oxley Act of 2002 (―Sarbanes-Oxley‖) was approaching, we stepped back and reviewed the initial decade of the Board’s enforcement program.1 This article provides our annual review of the PCAOB’s enforcement program over the prior year, as reflected in Board proceedings made public in 2013. Our update focuses on PCAOB proceedings ―made public‖ during 2013, because Sarbanes-Oxley restricts the Board’s ability to publicize enforcement actions against registered public accounting firms or their associated persons. In particular, Sarbanes-Oxley and Board rules prohibit the PCAOB from announcing or making its enforcement proceedings public until (1) the parties consent to a public hearing (which rarely occurs);
2
(2) the Board has imposed sanctions and the time to file an appeal with the
Securities and Exchange Commission (the ―SEC‖ or ―Commission‖) has expired;
3
or (3) the SEC, on
appeal, issues an order regarding the sanctions imposed.
4
In 2013, the PCAOB continued to express frustration with its inability to make its enforcement
proceedings public, with Board Member Jeannette Franzel arguing that the current process is ―not
sufficiently informative to investors, audit committees, auditors, or others interested in understanding audit
risks and challenges.‖
5
She further asserted that existing restrictions ―provide[ ] an incentive for
respondents to litigate matters regardless of whether they believe they ultimately will prevail, in order to
delay public disclosure.‖ Even so, the Board has been unable to persuade Congress to amend
Sarbanes-Oxley to eliminate the existing confidentiality requirements.
As a result, the Board can only provide general information regarding its current inventory of non-public
enforcement investigations and contested matters. For example, the PCAOB stated last year that it had
23 contested proceedings pending as of December 31, 2012 against registered public accounting firms
and individual auditors, but could not publicly disclose the specific allegations.
6
Board Member Franzel
also stated in July 2013 that the Board had approximately 90 informal inquiries, formal investigations and
non-public litigated proceedings currently in process.
7
In contrast, the PCAOB made public 17
enforcement proceedings in 2013, an increase from 11 in 2012. They include 13 proceedings that were
settled with the consent of the parties, and four adjudicated cases where the respondents had exhausted
their right to file further appeals or the time for the respondents to file additional appeals had expired.
While the 17 enforcement proceedings made public by the PCAOB in 2013 provide an imperfect window
into the Board’s enforcement program, they nevertheless offer valuable insight into the PCAOB’s recent
priorities. They include:
Several proceedings alleging that registered firms or their personnel had improperly interfered
with Board inspections or investigations, most notably by taking steps to modify or backdate audit
workpapers;
A number of cases alleging violations of basic auditing standards, including several proceedings
in which the Board determined that the failures were so severe as to warrant findings that the
auditors had engaged in fraud, in violation of Section 10(b) of the Securities Exchange Act of
1934 (the ―Exchange Act‖);
A case in which the PCAOB alleged that a ―Big Four‖ accounting firm had improperly allowed a
former partner to consult with engagement teams assigned to audits of the firm’s public company
clients, while that partner was subject to a one-year suspension from association with a PCAOBregistered firm;
Several proceedings alleging violations of auditor independence requirements, including the
performance of prohibited internal audit outsourcing services and a failure to comply with rules
that require the mandatory rotation of the lead audit partner on a public company engagement;
and
Several proceedings that serve as a reminder that the PCAOB may bring enforcement actions
against registered firms that fail to pay their annual PCAOB support fees or file annual reports
with the Board on a timely basis.
The most notable features of the PCAOB’s 2013 public enforcement proceedings are described below.
Taken as a whole, the proceedings suggest that most PCAOB enforcement actions involve serious and
repeated failures, often by smaller firms with limited public company experience, to comply with the Board’s auditing standards and other requirements, while the most severe financial penalties are imposed
in cases involving larger firms.
8
Notable Features of PCAOB Enforcement Proceedings Announced in 2013
Interference with Board Inspections and Investigations
As part of the Board’s initial standard-setting activities, the PCAOB adopted enhanced audit
documentation standards in 2004. These standards – now contained in AS 3 – require engagement
teams to document their audit procedures within 45 days of authorizing a client to make use of an audit
report in a required SEC filing, retain such documentation for a seven-year period, and carefully note any
subsequent additions to, or modifications of, their documentation.
9
Although this standard has now been
in effect for almost a decade, the PCAOB continues to identify instances in which firms or auditors fail to
comply with these requirements, and then seek to cover up the deficiencies by backdating or modifying
audit workpapers in the face of a Board inspection or enforcement inquiry.
The PCAOB views the submission of altered or backdated audit documentation to the Board as a threat
to the integrity of its processes, and has aggressively pursued cases against firms or individual CPAs who
have sought to cover up a failure to perform or document required audit procedures. Specifically, there
were seven proceedings made public in 2013 – more than one-third of the proceedings announced during
the year – that included allegations that registered firms or auditors had improperly backdated or modified
audit workpapers.
10
Of the cases finding such misconduct made public in 2013, the most egregious fact pattern included
allegations that the respondents, who were associated with two PCAOB-registered firms, coordinated the
backdating of workpapers for the 2007 audits of three clients at a ―firm retreat,‖ after learning of an
upcoming PCAOB inspection of one of the firms.
11
According to the Board, the respondents then
proceeded to backdate and sign workpapers that purported to document audit procedures that had not
been performed, added a handwritten list of supplemental audit procedures to the workpapers, and prepared and backdated letters required under PCAOB rules confirming the firm’s independence from two
of the three clients. These materials, in turn, were subsequently provided to the Board’s Inspection Staff
by the respondents, without acknowledging that the materials had been backdated. Following an
investigation by the Enforcement Division, the Board permanently revoked the registration of the two firms
with the PCAOB and permanently barred two individuals who had participated in the backdating from
association with a PCAOB-registered firm. The Board also ordered one of the individuals to pay a
$50,000 civil penalty.
In addition to the Gruber and Lee proceedings, the PCAOB announced several other actions against
registered firms and individual CPAs in 2013 that involved allegations of backdated or modified
workpapers. In two additional proceedings that involved PCAOB-registered firms, the Board revoked the
firms’ registration, but authorized them to reapply in two and three years, respectively.
12
The PCAOB also
censured and imposed a $10,000 civil penalty on each firm.
13
In the other matters announced in 2013 in
which individual CPAs were charged, the auditors were barred from association with a PCAOB-registered
firm, subject to the right to petition for reinstatement after periods ranging from 18 months to three
years.
14
With one exception, the backdating cases announced by the PCAOB in 2013 involved conduct by
auditors associated with smaller accounting firms, rather than with ―Big Four‖ firms. The exception was
the Suddeth case, in which a former Deloitte & Touche LLP (―Deloitte‖) engagement partner—but not
Deloitte—was charged with backdating three workpapers relating to a 2010 audit.
15
The Board’s Order
noted that Deloitte had uncovered the improprieties on its own, investigated the matter, voluntarily selfreported to the PCAOB, and relieved Suddeth of any audit-related responsibilities prior to his retirement in
2013.
Notably, the PCAOB announced the Suddeth proceeding roughly five months after the Board had
released a ―Policy Statement‖ addressing the circumstances under which the PCAOB may consider the
extent of a firm or associated person’s cooperation in determining the outcome of a Board investigation.
16
In that Statement, the Board describes ―voluntary and timely‖ self-reporting, remedial or corrective action
and/or substantial assistance to the Board’s investigative processes or to other law enforcement
authorities as ―extraordinary cooperation‖ that may influence the PCAOB’s enforcement decisions. The Suddeth case provides an example of a recent proceeding in which a registered firm’s self-reporting to
the Board of violations of professional standards by an associated person may have favorably impacted
the PCAOB’s assessment of the firm’s own conduct.
Significant Audit Deficiencies in Audits of U.S. and Foreign Issuers
During 2013, the Board announced several enforcement proceedings involving what the PCAOB viewed
as serious failures to satisfy basic auditing requirements.
17
These proceedings reflect: (1) the Board’s
continued focus on alleged audit deficiencies involving audits of foreign issuers; (2) cases in which the
PCAOB alleged that the misconduct was so severe as to warrant findings that violations of the antifraud
provisions of the Exchange Act had occurred; and (3) cases holding individual CPAs personally
responsible for firms’ failures to implement adequate systems of quality controls.
Allegations Involving Audits of Foreign Issuers: In 2013, the Board stated that its international program
remains a ―key focus‖ for the PCAOB.
18
It also reached a significant Memorandum of Understanding on
cooperation with Chinese authorities last year.
19
At the same time, the Board acknowledged that it still
―face[s] challenges in this arena, including persistent obstacles to inspections and enforcement in some
countries,‖ which the PCAOB avowed ―cannot continue indefinitely.‖
20
Despite these limitations, the
Board has sought to make its presence known in a number of matters involving audits of foreign issuers
by PCAOB-registered firms based in the United States and abroad.
For example, in a settled proceeding announced in 2013, the PCAOB alleged that P. Parikh
& Associates, a Mumbai-based firm registered with the Board, had committed ―numerous and repeated
violations of PCAOB rules, quality control standards, and auditing standards‖ in connection with its audits
of an SEC registrant based in New Delhi.
21
The Board noted that the firm, which had 17 partners and 14
offices (including seven offices outside India), had staffed the audits over a multi-year period with partners
who lacked formal training in either U.S. GAAP or PCAOB auditing standards. Finding the audits wholly
deficient, the PCAOB revoked the firm’s registration, subject to the right to petition the Board to reapply
for registration in two years.
The Board also announced two related enforcement actions in November 2013 that involved multijurisdictional audits of foreign issuers. These proceedings involved a U.S. accounting firm that had
agreed to serve as the external auditor of several issuers with their primary operations in the People’s
Republic of China or Hong Kong, and then looked to a Chinese firm to perform a significant portion of the audit procedures for those registrants.
22
As in the Parikh proceeding, the Board found that the accounting
firm had taken inadequate steps to ensure that the individuals conducting the audit procedures had
adequate training in U.S. GAAP or PCAOB auditing standards.
23
The Board also questioned the U.S.
firm’s capability to assume final responsibility for audits of China-based companies, noting that the
individual at the firm assigned such final responsibility did not speak, understand or read Chinese, and
instead ―relied on lower level accounting assistants with Chinese language skills‖ to review documents
and engage in critical communications with client management. The Acquavella and Svoboda
proceedings underscore that PCAOB-registered firms must take steps to satisfy themselves that they
either possess or have ready access to necessary resources, before agreeing to serve as the auditors of
companies that are headquartered or have significant operations in foreign jurisdictions with which they
may have limited experience.
24
Findings of Section 10(b) Violations: Securities practitioners typically look to the SEC and the federal
courts, rather than to the PCAOB, to define the scope of auditor liability under Section 10(b) of the
Exchange Act and Rule 10b-5. Both Sarbanes-Oxley and the Board’s rules provide, however, that the
PCAOB may investigate and sanction registered firms and associated persons found to have violated
provisions of the federal securities laws that relate to the ―preparation and issuance of audit reports.‖
25
The Board relied upon this authority in several 2013 proceedings in which the PCAOB found that firms or
their associated persons had violated Section 10(b) and Rule 10b-5.
According to the PCAOB, an auditor violates Section 10(b) and Rule 10b-5 ―by issuing an audit report
stating that the audit has been performed in accordance with PCAOB standards when he or she knows,
or is reckless in not knowing, that the statement is false.‖
26
In practice, it appears that the Board seeks to
apply a standard analogous to that articulated by the Southern District of New York in SEC v. Price
Waterhouse.
27
In that leading decision, Judge Sprizzo held that, to establish that an auditor violated
Section 10(b), the SEC ―must prove that the accounting practices were so deficient that the audit
amounted to no audit at all * * * or an egregious refusal to see the obvious, or to investigate the
doubtful, * * * or that the accounting judgments which were made were such that no reasonable
accountant would have made the same decisions if confronted with the same facts.‖
28 Specifically, in the proceedings made public in 2013 in which the Board alleged Section 10(b) and Rule
10b-5 violations, the PCAOB emphasized that there were intentional or reckless failures by auditors to
perform basic audit procedures that any reasonable accountant would have understood were necessary.
In one case, the Board found that a registered firm had issued an audit report that falsely stated that a
client’s 2006 and 2007 audits had been performed in accordance with PCAOB standards, when in fact
the firm had not performed any audit procedures before releasing its report.
29
In another 2013 case
where the Board found that a registered firm had violated the antifraud provisions, the PCAOB alleged
that the firm either knew, or was reckless in not knowing, that ―few substantive audit procedures were
performed‖ before the issuance of audit reports for three registrants.
30
And, in a third case involving
alleged Section 10(b) and Rule 10b-5 violations, the Board found that, among other things, the
respondents had issued reports on an issuer’s internal controls over financial reporting (―ICFR‖) without
familiarizing themselves with the relevant PCAOB auditing standards or performing any required ICFR
procedures, and in other cases failed to obtain engagement quality reviews required under PCAOB
standards before issuing audit reports.
31
Findings that a firm or associated person violated the antifraud provisions of the Exchange Act carry
particular weight, as they may be especially likely to trigger additional collateral consequences and
disclosure obligations for the respondents. While the cases announced by the Board in 2013
demonstrate that the PCAOB does not regularly allege violations of antifraud provisions under the federal
securities laws, they also show that the Board may do so if it identifies repeated failures to comply with
basic requirements.
Imposition of Secondary Liability on Individuals for Firm Violations: The most recent standard-setting
agenda issued by the PCAOB’s Office of the Chief Auditor (―OCA‖) notes that the OCA expects to
recommend that the Board issue a concept release in the second half of 2014 discussing potential
improvements to current quality control standards, including those addressing supervisory responsibilities
within PCAOB-registered firms.
32
In the interim, however, the Board has continued to cite violations of
Rule 3502 (―Responsibility Not to Knowingly or Recklessly Contribute to Violations‖) in proceedings where
it concluded that individual CPAs were responsible for their firms’ alleged failures to implement adequate
quality control systems and procedures.
33 Three such proceedings were announced in 2013. In the first, the Board found a Rule 3502 violation
where a senior partner was responsible for designing, communicating and monitoring his firm’s system of
quality controls, yet was aware that firm personnel responsible for several public company audit
engagements lacked relevant training or experience conducting audits in accordance with PCAOB
auditing standards.
34
In the second proceeding, the PCAOB sanctioned the managing member of a small
accounting firm in Florida, who also had overall responsibility at the firm for promoting compliance with
Board standards, after engagement teams under his supervision had failed to perform required audit
procedures to address fraud risks at their clients.
35
And, in the third proceeding, the Board found that the
sole audit partner at a small accounting firm had ―directly and substantially‖ contributed to his firm’s
violation of AS 7 by permitting the firm to issue audit reports without previously having obtained an
engagement quality review by another auditor who concurred in the engagement team’s conclusions.
36
The Rule 3502 violations alleged in these proceedings underscore both the importance which the PCAOB
attaches to firms’ systems of quality controls and the potential risk assumed by senior individuals at
PCAOB-registered firms with quality control or risk management responsibilities.
Failure to Monitor the Post-Suspension Activities of a Former Partner
In the only 2013 proceeding in which a ―Big Four‖ firm was named as a respondent, the PCAOB
sanctioned Deloitte for allowing a former partner who was subject to a bar on association with a PCAOBregistered firm to participate in various consultations with Deloitte audit teams working on public company
engagements.
37
This proceeding raises important issues as to what it means to be an ―associated
person‖ of a registered public accounting firm, as well as what steps firms need to take when one of their
partners or employees becomes subject to a Board suspension.
The 2013 case arose as a result of a prior Board action in 2008, in which the PCAOB had barred Deloitte
partner Christopher Anderson from association with a PCAOB-registered firm, with a right to petition the
Board for reinstatement in one year.
38
In anticipation of the Board’s sanction, Deloitte restructured
Anderson’s responsibilities at the firm, and Anderson also stepped down as a Deloitte partner and
became a salaried employee of the firm. These steps were apparently taken with the goal of ensuring
that Anderson’s post-suspension activities at Deloitte would not cause him to remain an ―associated
person‖ of the firm under the Board’s rules or run afoul of the 2008 Order.
39
Moreover, Deloitte had some
discussions with the PCAOB’s Staff regarding its plan to retain Anderson as a salaried employee during
the term of his Board-ordered suspension.
Nevertheless, the Board found that Deloitte violated Section 105 of Sarbanes-Oxley and PCAOB Rule
5301 by allowing Anderson to work in a National Office position in Deloitte’s Audit and Assurance
Services Group, which handled consultations with engagement teams and developed firm-wide audit
policies and guidance. Deloitte affirmatively restricted Anderson’s activities in numerous respects; for
example, he was prohibited from signing audit reports for public company audit clients, accepting new
public company audit engagements, or serving as a ―concurring reviewer‖ on such engagements.
Instead, Deloitte’s intent apparently was that Anderson’s responsibilities would be limited to broader, firmwide topics, such as general audit guidance on the appropriate use of specialists by audit engagement
teams. According to the Board, however, Anderson consulted directly in his new National Office role with
engagement teams assigned to the audits of three public company clients of the firm while still subject to
the prior suspension.
In the Board’s opinion, such client-specific consultations were inconsistent with the 2008 Order, and a
result of Deloitte’s not having developed adequate procedures to define and monitor Anderson’s postsuspension activities at the firm. As part of its settlement, Deloitte agreed to be censured and to pay a
$2.0 million civil monetary penalty (tying the highest penalty ever assessed by the Board against a
registered firm in a settled proceeding). In addition, Deloitte confirmed that it had adopted new
procedures, including an undertaking to communicate the job responsibilities of Board-restricted
individuals ―to the PCAOB staff in advance of or contemporaneously with the term of any suspension.‖
Accordingly, the Deloitte case indicates that firms can retain valued professionals who become subject to
PCAOB suspensions, but that they must monitor their activities (and may wish to pre-clear the scope of
their activities during the suspension period with the PCAOB’s Staff).
Independence Violations
While the PCAOB launched no new standard-setting initiatives in 2013 relating to auditor independence,
Chairman Doty questioned in a December 2013 speech whether the recent growth of accounting firms’
consulting practices may impact firms’ independence.
40
Further signaling the Board’s continued interest
in auditor independence, the PCAOB alleged violations of existing independence rules in two
enforcement proceedings made public during 2013.
In the first proceeding, the Board found that a registered firm and one of its associated persons provided
prohibited internal audit outsourcing services to an issuer, in violation of Section 10A(g) of the Exchange
Act and PCAOB Rule 3520.
41
In the second proceeding, the PCAOB found that a partner at a firm had
served as the lead engagement partner on audits for two issuers for more than five consecutive years, in
violation of the partner rotation requirements under SEC and PCAOB independence rules. Accordingly,
the Board held the partner and his firm responsible for violations of Exchange Act Section 10A(j) and Rule
10A-2 thereunder, as well as for violations of Board rules.
42
In both proceedings, the PCAOB imposed
significant sanctions on the firms and individual partners, although the independence violations were not
the sole basis for those sanctions. Failures to File Annual Reports and Pay Annual Dues on Timely Basis
The PCAOB has been announcing several enforcement cases every year against registered public
accounting firms that fail to file annual reports, or pay required annual support fees, on a timely basis.
2013 was no exception. In two of the four cases involving such allegations made public in 2013, the
Board settled with the delinquent firms, each of which paid the overdue fees, filed the overdue annual
reports, and filed Form 1-WDs with the PCAOB seeking to withdraw their registration with the Board. The
two firms also agreed to a censure and the imposition of modest fines.
43
In comparison, the other two cases made public in 2013 were adjudicated proceedings. They are notable
primarily because they indicate how the relief sought by the PCAOB’s Enforcement Division may differ
from the sanctions judged appropriate by a Hearing Officer. In one of the proceedings, which involved a
sole proprietorship, the Enforcement Division had sought a one-year suspension of the respondent’s
registration with the Board, but the Hearing Officer found this sanction insufficient, in light of the repeated
opportunities that the PCAOB had given him to comply with his obligations and avoid disciplinary
sanctions.
44
Instead, the Hearing Officer found that the respondent engaged in intentional or knowing
misconduct, permanently revoked his registration with the Board, and imposed a $5,000 civil monetary
penalty.
In the other adjudicated proceeding made public in 2013 involving a failure to file required annual reports
or pay support fees, the Enforcement Division recommended a one-year suspension and a $7,500
penalty. The Hearing Officer agreed that the respondent had engaged in ―repeated instances of negligent
conduct‖ and suspended the respondent for one year, as recommended by the Enforcement Division, but
reduced the civil penalty to $2,500.
45
The respondents in these two adjudicated proceedings did not appeal the Hearing Officer’s decision to
the full Board. Had they done so, however, the Board also could have increased or reduced the
sanctions recommended by the Hearing Officer, or decided to impose no sanctions at all. The
proceedings thus suggest that, depending upon the stakes and the findings made by a Hearing Officer,
either or both parties to a contested Board proceeding – the respondent or the Enforcement Division –
may have an incentive to pursue appeals to the full Board (and then possibly to the SEC as well). Conclusion
The number of enforcement proceedings announced by the PCAOB in 2013 increased over the
number in 2012, and the Board has publicly stated that it currently has a large inventory of both
investigations and contested proceedings in the pipeline. A review of the proceedings made
public in 2013 indicates that the PCAOB’s Enforcement Division is continuing to pursue a range
of cases and also looking to further expand its reach, both substantively and territorially.
Substantively, the Board’s expanded authority to regulate auditors of SEC-registered brokerdealers is likely to generate additional enforcement cases in the future.
46
From a geographic
standpoint, the Board’s continued focus on the qualifications and performance of U.S. firms
auditing foreign issuers and its entrance into new cooperation agreements with foreign regulators
also can be expected to give rise to additional investigations and enforcement proceedings. At
the same time, the Enforcement Division likely will continue to pursue ―bread-and-butter‖ cases
involving, for example, situations where auditors interfere with Board inspections or investigations
by backdating or altering audit workpapers or fail to satisfy basic requirements under existing
standards.
