The PCAOB Inspection: How Can Your PCAOB-Registered Clients Reduce Their Likelihood of Being Subject to PCAOB Sanctions and Other Disciplinary Action?

In recent years, the Public Company Accounting Oversight Board (“PCAOB”) has sharply criticized and issued disciplinary sanctions against public accounting firms who have taken an overly relaxed approach to difficult valuation items in their audit work files. Attorneys representing accounting firms registered with the PCAOB must be aware of the ramifications of their clients failing a PCAOB inspection. PCAOB scrutiny can be addressed proactively through the use of independent valuation experts in a quality control review of the auditors’ documentation of fair value measurements. Audit work files benefitted by such a review are better able to safeguard against PCAOB critical scrutiny, and avoid severe disciplinary sanctions.

In an article published by CFO.com on June 18, 2007 titled, PCAOB: Deloitte Fails on Fair-Value Testing,⁽²⁾ the author, Sarah Johnson, describes how PCAOB inspectors spent nearly six months reviewing Deloitte’s 2005 audit work papers, noting multiple deficiencies in Deloitte’s auditing of fair value measurements. The article discusses that this PCAOB scrutiny came on the “heels of comments by [then] PCAOB chairman Mark Olson expressing growing concern about whether audit firms have the ability to properly audit fair-value accounting at companies.”⁽³⁾ In fact, recent testimony by Daniel Goelzer (the PCAOB’s current acting chairman) indicates that the audit of fair-value measurements continues to be a central focus of the PCAOB.⁽⁴⁾ Thus, it is clear that PCAOB inspectors will likely focus on fair value measurements when it comes time for your PCAOB-registered client’s inspection.

Amongst other things, the PCAOB is responsible for conducting inspections of registered public accounting firms, conducting investigations and disciplinary proceedings and imposing appropriate sanctions on these firms and their staffs. There are two types of PCAOB inspections – special and regular. Regular inspections occur periodically based on the number of audit reports generated by a firm and are designed to examine and test the audit, supervisory, and quality control procedures employed by the registered audit firm.⁽⁵⁾ Special inspections are limited to an examination of issues determined at the PCAOB’s discretion.⁽⁶⁾ During these inspections, the audit firm and its employees are required to cooperate with the PCAOB, allowing for full access to and the ability to make copies of the audit firm’s work papers.⁽⁷⁾ The audit firm must also be prepared to provide oral and written responses to comments and questions from the PCAOB inspectors. Should violations be found, the violation or violations may be reported to the SEC and state regulatory offices, and may trigger a PCAOB investigation.⁽⁸⁾

If an investigation is deemed necessary, the PCAOB can receive information from any source, and will decide on proceeding by initiating either a formal or informal investigation. An informal investigation is initiated when “it appears that, or [the PCAOB] determines that, either the firm or an individual has violated any provision of the Sarbanes-Oxley Act, any PCAOB rule, any professional standard, and any provision of the securities law relating to the preparation and issuance of audit reports and the obligations and liability of accountants thereunder.”⁽⁹⁾ If enough data is found, then a formal investigation may ensue.

A formal investigation starts with the issuance of an “Order of Formal Investigation.” The investigators have the right to inspect records, people, and firm documentation in order to verify the “accuracy of the documents or information.”⁽¹⁰⁾ The conclusion of the investigation is to determine whether or not a disciplinary proceeding is required. A proceeding will occur if a firm or its employees are deemed to have violated any provision of the Sarbanes-Oxley Act, Rules of the PCAOB, or any provisions of the securities laws regarding preparation and issuance of audit reports, or any professional standard.

The PCAOB has the power to require registered firms to hire an independent monitor to “observe and report,” which could lead to further investigations, fines up to $100,000 per violation per person, or up to $2.0 million per violation per firm.⁽¹¹⁾ For example, Deloitte was fined $1.0 million for not following the PCAOB’s standards in connection with its 2003 audit of a pharmaceutical company.⁽¹²⁾ If the fines are not paid, the PCAOB can summarily suspend or bar a firm’s or person’s registration. Such a penalty could serve as a death knell to a firm or its professionals by effectively preventing the sanctioned party from providing audit related services – likely its major source of revenues. For example, accounting firm Kantor, Geisler & Oppenheimer’s (KGO) PCAOB license was revoked and two accountants from the firm were barred from working in public accounting.⁽¹³⁾

What the examples above show is that PCAOB fines and sanctions can be extremely costly to your PCAOB-registered clients. Further, the inspection, investigation and disciplinary process can be very time consuming and detract from your client’s primary operations – conducting audits. Thus, your clients should be counseled to retain valuation experts to assist in analyzing and documenting the fair value measurements within the audit work papers in order to minimize the likelihood of PCOAB sanctions and penalties. This will enable your clients to make the inspection process as efficient as possible, precluding the time and costs of an investigation and disciplinary proceeding.

While the primary onus is on the auditor, a PCAOB inspector’s comments on audit work files may cast a pall not only on the auditor but also on the auditor’s corporate client and those responsible to them. Appropriate experts with proper valuation expertise can serve as critical members of your PCAOB-registered clients’ audit teams as they can provide needed feedback and documentation relating to the veracity of fair value measurements. Marcum’s valuation professionals have the requisite skills to assist your PCAOB-registered clients who want to proactively minimize the likelihood of PCAOB sanctions and those who are currently undergoing a PCAOB investigation. Through a thorough and rigorous process, verification of fair market measurements can be observed, noted, and documented in order to bolster the audit work papers or to exonerate those parties being investigated by the PCAOB for allegedly not employing proper audit procedures or failing to make appropriate documentation of fair value measurements.

PCAOB inspections are a normal and necessary aspect of public accounting. With respect to the audit of fair value measurements, additional expenses related to PCAOB scrutiny and sanctions can be avoided by a thorough quality control review from a qualified independent valuation professional.

1. Senior Associate, Advisory Services Group – Philadelphia office. Michael specializes in business valuations.
2. Sarah Johnson, PCAOB: Deloitte Fails on Fair-Value Testing, cfo.com, Jun. 18, 2007, http://www.cfo.com/article.cfm/9355231?f=related
3. Id.
4. See Daniel Goelzer’s testimony before the House of Representatives Financial Services Committee at http://pcaobus.org/News/Speech/Documents/05212010_Goelzer_HFSC_Testimony.pdf (indicating that the PCAOB plans on adopting final standards for fair value measurements and other accounting estimates by the third quarter of 2011). See also the PCAOB’s website at http://pcaobus.org/Featured/Pages/FairValue.aspx (demonstrating that fair value measurements is currently a “featured issue” on the PCAOB’s radar).
5. See Dennis K. Spillane, PCAOB Enforcement: What to Expect, The CPA Journal Online, Sept. 2004, http://www.nysscpa.org/cpajournal/2004/904/essentials/p32.htm
6. See Id.
7. See Id.
8. See Id.
9. See Id.
10. See Id.
11. See Id.
12. See Sarah Johnson, PCAOB Fines Deloitte $1 Million, cfo.com, Dec. 10, 2007,http://www.cfo.com/article.cfm/10277538?f=related. See also the PCAOB’s website at http://pcaobus.org/Enforcement/Decisions/Pages/default.aspx (publishing final disciplinary orders rendered by the PCAOB).
13. See Alan Rappeport, PCAOB Sanctions Three Auditors, cfo.com, Dec. 17, 2007, http://www.cfo.com/article.cfm/10317705/c_10313688