Although the state and federal wage and hour laws governing eligibility for overtime pay are complicated, the public policy issues they present for audit firms are not.
The largest public accounting firms want entry-level accounting graduates to feel like professionals, by virtue of their university degree, the potential to take the Certified Public Accounting (CPA) exam, and their eligibility to be licensed eventually. But when it comes to eligibility for overtime – or rather exemption from overtime – it’s not who you think you are or where you came from but what you actually do that matters most.
The education of accounting majors consists, in the worst case scenario, of being “taught the exam” and, in the best case, of four to five years of head-down, hard-core study and rote memorization of facts with rarely any time for other outside reading, enrichment, travel, or world view development. If all goes well, the student gets the highest grades – the Big 4 limit interviews to only tippy-top students – and has a choice of internships and then full-time positions.
The firms take that raw material and, via constant on-the-job training, turn it into a finished product that can hopefully perform some portion of an audit of a public company after five or six years. The roles and responsibilities – and time served – at each level within the firm are rigidly defined. At each step along the way, there is another young professional with only a year of experience more who is assigning tasks and reviewing your work, until you’re promoted to manager.
At the manager level, most firms require you to be licensed – even though the only one who can take ultimate responsibility for an audit and sign the opinion is a qualified partner – and the assignments are more focused on the industry or technical aptitude you may have demonstrated along the way. Until then, most firms still treat individuals as fungible, pooled resources, assigned to teams or tasks by a central scheduler based on availability, location, and personal qualities. Dynamics between team members and between team members and client contacts become more important success factors over time.
This is how Deloitte describes the day-to-day:
Whether you work in Audit Services or Enterprise Risk Services, you can expect to devote a significant amount of time at the client site with your team. You might spend part of your day talking to clients at various levels (from the accounts payable clerk to the CFO). You may examine documents, cancelled checks, and general ledgers, documenting your observations for your clients and team members.
Your team’s structure may vary. For a large engagement, there may be as many as 20-25 people on a team. You may work on multiple client accounts simultaneously. Engagements can be regionally, nationally, or globally focused, and usually involve close interaction with the client’s senior management.
During the first three to four years, most of the professionals are still unlicensed although some may have, by now, passed the CPA exam. All the states have some kind of experience requirement before licensing depending on how many university credit hours are required to take the exam and/or obtain a license.
Because they are unlicensed, these employees do not meet the easiest test for exemption – being licensed or certified. In California, the professions covered by this straightforward exemption are listed and include accounting.
However, the Ninth Circuit Court of Appeals disagreed with the District Court that the “professional exemption” is completely unavailable to unlicensed accountants. They recently reversed an earlier decision that precluded, as a matter of law, the use of the “professional exemption” for unlicensed accountants:
We reject Plaintiffs’ argument that exclusivity between the second and third categories implies exclusivity between the first category and the latter two. We see nothing in the text or structure indicating that enumerated professions (subsection (a)) cannot in some instances also be either learned or artistic professions (subsection (b))…
[S]ubsection (a) is much easier for an employer to prove. Subsection (a) precludes the factual disputes for which subsection (b) is a veritable hotbed—even in this case—about the employee’s actual job duties and whether those duties meet the requirements of a “learned” or “artistic” profession.
In the Campbell v. PwC case, PwC will have an opportunity to prove, if they choose to go that route, that duties performed by the entry level employees in their audit practice meet the requirements of a “learned” profession.
(i) Work requiring knowledge of an advanced type in a field or science or learning customarily acquired by a prolonged course of specialized intellectual instruction and study, as distinguished from a general academic education and from an apprenticeship, and from training in the performance of routine mental, manual, or physical processes, or work that is an essential part of or necessarily incident to any of the above work; or
(ii) Work that is original and creative…and
(iii) Whose work is predominantly intellectual and varied in character (as opposed to routine mental, manual, mechanical, or physical work)
I can’t imagine the lawyers will go so far as to claim that accounting is an “art” and auditors are “artists”. That would certainly test the limits of good public policy.
The audit firms can also testify that the unlicensed employees are not eligible for overtime because they meet an “administrative” exemption. This exemption, in California for example, is defined as:
Administrative Exemption. A person employed in an administrative capacity means any employee:
(a) Whose duties and responsibilities involve either:
(i) The performance of office or non-manual work directly related to management policies or general business operations of his/her employer or his/her employer’s customers; or
(ii) The performance of functions in the administration of a school system, or educational establishment or institution, or of a department or subdivision thereof, in work directly related to the academic instruction or training carried on therein; and
(b) Who customarily and regularly exercises discretion and independent judgment; and
(c) Who regularly and directly assists a proprietor, or an employee employed in a bona fide executive or administrative capacity (as such terms are defined for purposes of this section); or
(d) Who performs under only general supervision work along specialized or technical lines requiring special training, experience, or knowledge; or
(e) Who executes under only general supervision special assignments and tasks; and
(f) Who is primarily engaged in duties that meet the test of the exemption.
The Code of Federal Regulations explains an important component of the administrative exemption – the exercise of discretion and independent judgment – more fully:
§ 541.202 Discretion and independent judgment
To qualify for the administrative exemption, an employee’s primary duty must include the exercise of discretion and independent judgment with respect to matters of significance. In general, the exercise of discretion and independent judgment involves the comparison and the evaluation of possible courses of conduct, and acting or making a decision after the various possibilities have been considered. The term ‘‘matters of significance’’ refers to the level of importance or consequence of the work performed.
There are two reasons that arguing the administrative exemption for audit associates is contrary to public policy.
The first is that more than one judge has already told the audit firms that expecting audit associates to perform, “office or non-manual work directly related to management policies or general business operations of…his/her employer’s customers, “ is contrary to auditor independence rules.
In the overtime case against KPMG in Washington State court, Litchfield v. KPMG, the judge concluded the following:
“The independence rules of the accounting profession as a matter of law preclude accountants performing work on audit engagements from qualifying for the administrative exemption.”
The judge determined that KPMG cannot invoke the administrative exemption in the overtime case without compromising the SEC-required obligations for auditor independence. Nevertheless, KPMG (and the other Big Four firms) have continued to defend against the imposition of overtime pay by claiming unlicensed audit staff perform administrative work for their audit clients.
Just this past April, KPMG again asserted the administrative exemption as a defense to the overtime case filed against them in the federal district court in New York, Pippins v. KPMG. Note also that the firm defending KPMG in the Litchfield case, Orrick, Herrington & Sutcliffe, is the same firm that defended PwC at the district court stage in the Campbell v. PricewaterhouseCoopers case.
I suppose it’s not surprising KPMG might think they can get away with this open flaunting of the independence rules. After all, they are performing administrative tax work – work that should be done by the client’s staff – for century-old audit client GE.
The firms have created a Hobson’s choice for the entry-level auditor. Their immediate superiors may ask them to do robotic, routine, data entry into pre-programmed audit software, scan hundreds of documents, or to ask questions of a senior client employee while using discretion and judgment in deciding if they’ve heard true and complete information.
Either way, their choice is only to do what they’re told. During busy season they have been known to follow orders for 60-80 hours per week.
But when audit firms expect entry-level professionals to, “exercise discretion and independent judgment with respect to matters of significance,” they are perpetuating performance requirements that contradict PCAOB Auditing Standards in service to avoiding overtime pay.
More likely, the firms’ first objective is to perpetuate artificial status and value in the eyes of both college graduates and audit clients so the firms can continue to attract bright-eyed graduates and justify higher than necessary fees for work that is performed by the least experienced, but least costly, resources under general, or less than general, supervision by partners.
The PCAOB’s Auditing Standards say that as the risk of material misstatement increases, the supervision of engagement team members by partners should increase. When “matters” become “material” the entry-level audit associates are not supposed to be going it alone.
Effective Date: For audits of fiscal years beginning on or after Dec. 15, 2010
6.To determine the extent of supervision necessary for engagement team members to perform their work as directed and form appropriate conclusions, the engagement partner and other engagement team members performing supervisory activities should take into account:
§ The nature of the company, including its size and complexity;
§ The nature of the assigned work for each engagement team member, including:
(1) The procedures to be performed, and
(2) The controls or accounts and disclosures to be tested;
§ The risks of material misstatement; and
- The knowledge, skill, and ability of each engagement team member.
Note: In accordance with the requirements of paragraph 5 of Auditing Standard No. 13, The Auditor’s Responses to the Risks of Material Misstatement, the extent of supervision of engagement team members should be commensurate with the risks of material misstatement.
Compare what the PCAOB said in a recent disciplinary order with what PwC is claiming in the California overtime litigation. (Unlike what the Big Four say in open court, such as the quotes below from PwC, the Big Four have designated nearly all of the evidence in these cases as confidential and/or documents have been filed in court under seal. These transcripts, here and here, therefore provide rare insight into PwC’s claims about their unlicensed audit assistants that would not otherwise be public.)
I’m calling on the PCAOB, and the SEC, to investigate the use of these specious arguments that are contrary to public policy, contrary to the regulatory goals of both agencies, and violate the Sarbanes-Oxley Act of 2002 amongst other laws and professional standards. How can the regulators also condone the AICPA and state CPA societies who prepare amici briefs in support of these contra-public policy arguments? How can they not condemn groups like the US Chamber of Commerce for also supporting performance expectations for entry-level professionals that dilute and diminish the value received by Fortune 500 companies during their audit?
What’s even more strange is the SEC and PCAOB allow a double legal compliance standard amongst the registered public accounting firms. Most small, medium, and regional public accounting firms are forced to operate on a different business model because they do pay their unlicensed professionals overtime in compliance with state laws that are clear to them.
The audit firms should no longer be allowed to perpetuate the myth in the judiciary – via settlements, seals, and gag orders – that it’s acceptable that so much is being done in service to the capital markets by employees at the very bottom of the hierarchy.