Public Company Accounting Oversight Board; Will It Protect Investors?

Public Company Accounting Oversight Board; Will it Protect Investors?

The Public Company Accounting Oversight Board (PCAOB) was created by Sarbanes-Oxley Act of 2002. This board was created to oversee the audit of public companies, subject to the securities laws, in order to protect the interests of investors (15 USC 7201, 2002). It was created in wake of the recent financial scandals of Enron, WorldCom, and Global Crossing to name a few. This "Act" established by Congress is to create an oversight board, so that such scandals will never occur again. Will this oversight board work and will its work restore public confidence and encourage individuals to invest in the stock market again?

The PCAOB is not a tax-payer funded agency. It is supported by over 8800 companies and mutual funds that benefit from independent audits (Epstein). The PCAOB principle duties are;

1. Register public accounting firms that prepare audits.

2. Establish and/or adopt standards relating to the preparation of audit reports for issuers.

3. Conduct inspections of registered public accounting firms.

4. Conduct investigations and disciplinary proceedings.

5. Promote high professional standards and improve the quality of audit services offered by registered public accounting firms.

6. Enforce compliance with the Sarbanes-Oxley act (15 USC 7201, 2002).

Before the establishment of Sarbanes-Oxley and the PCAOB, there was no oversight board. Public accounting firms would perform "peer reviews" to verify that audits were being performed with due diligence. However, these reviews were not high priority, thus uncovering errors/negligence made by the public accounting firms by peers were rarely discovered. It was only after the massive failures of Enron and WorldCom that this gross negligence by the public accounting firm performing the audit came to light. It was clear that an independent review board was necessary to ensure due diligence is being followed when a public accounting firm audits a corporation.

The PCAOB will examine yearly those public accounting firms with more than 100 publicly-traded audit clients. All others will be examined every three years. Any violations of Sarbanes-Oxley or SEC and the PCAOB may fine or disqualify firms from public accounting audits (Epstein). The power to fine or disqualify a public accounting firm from performing audits will encourage such firms to use due diligence when conducting an audit of a company.

The PCAOB was not limited to simply reviewing public accounting firms, but also to create standards that public accounting firms must follow. The first standard requires public accounting firms registered with the PCAOB to include in their reports on engagements performed pursuant to the PCAOB's auditing and related professional practice standards a reference to the standards of the PCAOB.

The second standard requires public accounting firms to audit internal controls in conjunction with an audit of financial statements. The second standard requires public accounting firms to attest that the internal controls documented and set forth by the company audited are sufficient to ensure the integrity of the financial statements (Griggs). This second standard is a real breakthrough in ensuring the financial statements of a company are sound. It is impossible for a public accounting firm to audit every detail of large multi-national company. Strong internal controls reduce the risk of material misstatements to a company's financials caused by negligence or fraud. Maintaining internal controls is no longer enough. Companies must now analyze and document their internal processes (Calabro). When a public accounting firm issues an unqualified opinion on the internal controls of a company, which will be required starting November 15, they are stating that the internal checks set forth adequately protect the assets of a company from negligence or fraud.

There are concerns regarding Auditing Standard 2. One such concern is because controls audits is such a new process, auditing firms can extend the scope of their work as they go along, which can add significant expense to an audit (Calabro).

So who is responsible for leading the PCAOB to take the necessary steps to restore investor confidence? The chairman of the PCAOB, William McDonough, states that the PCAOB will be "stern but sympathetic supervisors" (Michaels). It appears that McDonough is taking a tough love approach, the approach he used as the president and CEO of the Reserve Bank of New York. He states; "Most of the time (at the Fed) we'd be supportive, helpful - but if you do something wrong, watch out