The Enforcer

If audit firms don't voluntarily improve their processes, PCAOB chairman William McDonough promises he'll make them.

Part of the work will be a very intense look at the overall management and conduct of the firm, what we call “tone at the top.” Are they getting the message across that audit is their most important product? Are good auditors being compensated for being good auditors — not for bringing in collateral business, the cancer that destroyed Arthur Andersen?

We will also be looking at individual audit engagements. Last year we examined 16 in each Big Four firm. This year we will be doing several hundred each. The reviews are very thorough. We review the work papers, interview the engagement partner, the partner that reviewed the engagement partner’s work, and then talk with people involved in the audit, to see whether this message of absolutely high-quality audits is being carried to the rank and file.

Will the interview extend to the people who are being audited — the companies?

Generally not. Last year there were telephone discussions in quite a number of cases with the chairpersons of some audit committees. This year [the issuers audited] will be slanted heavily toward high-risk engagements, and a random sample of others. But, generally speaking, we will be looking at the auditor rather than the auditee.

Obviously, these inspections are supposed to identify what needs to be changed. What in your view will constitute a weakness?

All kinds of things. Let’s say we discover that the issuer has made what appears to be an accounting mistake. Since we are not in the accounting-theory business but rather the audit business, we would say to the auditor and the issuer, “We question your application of GAAP.” Then, if they wished to appeal to a different authority, they could go to the SEC.

On the other hand, if we felt that the audit firm simply was not conducting very high-level audits, that would be a quality issue. Depending on the gravity of it, we would say, “This is so serious we will [open] an investigation with the possibility of an enforcement action,” or, “We want this fixed within the next 12 months and the details will remain confidential.” Our capabilities [range] from quiet advice to putting them out of business.

You say that you won’t be talking to clients. Yet some CFOs are preparing their finance staffs for PCAOB audits as well as potential SEC inspections.

They are making a leap that I’m not sure I agree with. It would happen if we were so confused by what was going on in an audit that we simply had to go to the issuer. But it certainly wouldn’t be a frequent event.

How do you respond to auditors’ insistence that it isn’t their job to detect fraud?

We have a very clear view that it is their job. If we see fraud that wasn’t detected and should have been, we will be very big on the tough and not so [big] on the love.

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