The SEC vs. The PCAOB and Jim Doty: Impasse or Détente?

Jim Doty’s term as chairman of the PCAOB, the audit regulator, expired in October.  All summer since I arrived in Washington D.C., leading up to that date and since, there’s been speculation about whether or not SEC Chairwoman Mary Jo White would reappoint him to the job.

I wrote quite a bit on the subject in the last few months, even though my beat is now much broader and the PCAOB is, in the realm of financial regulation, still sort of a unicorn.  According to Wikipedia, Marco Polo described unicorns as “scarcely smaller than elephants. They have the hair of a buffalo and feet like an elephant’s. They have a single large black horn in the middle of the forehead… They have a head like a wild boar’s… They spend their time by preference wallowing in mud and slime. They are very ugly brutes to look at.”  

I think many, including the Big Four public accounting firms, might agree with that comparison.

On July 7 I wrote about the SEC’s competing proposal for audit partner identification.

The SEC’s proposal puts the onus for disclosure on the companies and their audit committees rather than reinventing the wheel and duplicating production of information the audit firms likely already provide to the PCAOB for inspection purposes. Although the PCAOB says the information on the new form, to be called Form AP, could also benefit the regulator’s oversight activities, according to people familiar with the matter, the PCAOB already asks for this information on an annual basis from the nine annually inspected audit firm, the ones who perform more than 100 public company audits.

I said a little bit more about these competing proposals in December on this blog right before the PCAOB approved their version.

For the record, I am in favor of the SEC proposal for naming audit partners versus the PCAOB version because the PCAOB version would allow the firms to hide bad auditors, like priests accused of abuse,  longer and better. The PCAOB version will makes it so much harder to develop an engagement record by partner, to compare performance such as number of restatements across public company audits and to see how many times they have been named in litigation or disciplined.

And I wrote in MarketWatch that some key people agreed with me.

Law firm Baker and McKenzie’s Dan Goelzer writes in his monthly update to clients that the competition between the Securities and Exchange Commission and the Public Company Accounting Oversight Board over who should mandate audit partner disclosure should be resolved in favor of the SEC. Goelzer is a former general counsel of the Securities and Exchange Commission and a founding board member of the PCAOB. “In light of the SEC’s broad statutory responsibility for disclosure-based investor protection, the issue of whether and how this type of information should be disclosed would seem to fall squarely within its jurisdiction,” he says. He goes on to say that any disclosure of the audit partner name to the public will result in more work and more costs for audit committees. Audit committees would now need to be aware of litigation, restatements or similar events arising in other audits led by their engagement partner. “Audit committees will have to focus on the engagement partner’s record with respect to other engagements, and that is something that many audit committees aren’t much aware of today,” he said in an interview.

In September the U. S. Chamber of Commerce complained to the SEC about the PCAOB.

The Chamber said in a letter to the PCAOB in May that its members believe the PCAOB, the independent auditing regulator established by the Sarbanes-Oxley Act of 2002, is imposing new “burdens” on business by using the inspections process to pressure auditors to ask more of companies.

Later in September, the law firm that employs Mary Jo White’s husband, John White, deleted some info from its website to try to assuage critics who said White should recuse herself from the Doty decision because of her husband’s ties to the PCAOB.

A move by the law firm Cravath, Swaine & Moore to excise references to uncommonly close regulatory ties follows a Bloomberg story that pointed to an ongoing conflict between John White’s service to the group while his wife, Securities and Exchange Commission Chairwoman Mary Jo White, has oversight responsibility for the Public Company Accounting Oversight Board, the audit regulator.

In October a coalition of activists pushed the issue of White and her husband’s possible conflicts with regard to the PCAOB and Doty appointment even further.

A national coalition of 14 organizations told Mary Jo White, chairwoman of the Securities and Exchange Commission, to take herself out of the selection process for the next chair of the Public Company Accounting Oversight Board, the audit regulator.

In a letter sent on Thursday the signers said they believe there’s a conflict of interest created by her decision on an issue that will impact her family’s income. That’s because John White, her husband, is a member of the PCAOB’s Standing Advisory Group, selected by the board of the PCAOB, who are in turn chosen by the SEC and White.

At the AICPA Annual Conference on SEC and PCAOB issues in early December, I thought perhaps the tide had turned and wrote that I thought Doty would keep his job.

Mary Jo White, chairwoman of the Securities and Exchange Commission, delivered strong words of support Wednesday for the work of the Public Company Accounting Oversight Board and its incumbent chairman, in remarks that suggest she may renominate him to the role.

In early September, multiple media outlets reported White was considering other candidates for the PCAOB chair role, held now by James Doty.

Doty has said he would like to remain as chairman but his focus on structural reforms of the industry has generated criticism of his tenure, including by the SEC’s chief accountant and a former commissioner.

Several times during her remarks on Wednesday White credited Doty, the PCAOB and its audit quality initiatives for the few bright spots in the world of financial reporting and audit quality.
But throughout the AICPA conference it seemed the SEC and the PCAOB were waiting for another shoe to drop.  Charles Levinson of Reuters had been working on the story of the conflict between the SEC and PCAOB, with the Big Four accounting firm leaders playing a supporting role as a critical chorus, for months.  I had talked to him more than once.  When the story came out a week later on December 16, it was apparent why both regulators had been so nervous about it.
Levinson documents several lurid, embarrassing, and highly personal jabs at Doty by those in and out of the SEC.
Doty’s efforts have floundered, in large part because Schnurr’s office has used its oversight powers to block, weaken and delay them, according to a dozen current and former SEC and PCAOB officials. Schnurr’s staff has also campaigned to have Doty removed from office, these people said…
Some Big Four accounting firm officials, meanwhile, say the tensions with the PCAOB stem from turf battles and personality clashes and aren’t part of any industry effort to undermine a tough watchdog. The Big Four say they don’t oppose regulations that improve standards, but believe the PCAOB would be more effective if it pushed rules focused on the nuts and bolts of auditing…
The PCAOB began aggressive yearly inspections of audits by U.S. accounting firms and published its findings in lengthy reports for each firm. It was a dramatic change from the pre-Enron days, when big firms chummily policed each other through an industry-run self-regulator.

“Many thought this new regulator was behaving a little aggressive,” said a former Deloitte partner…

For months, Doty negotiations with Beswick and Croteau went nowhere. Tensions came to a head at Doty’s 8th floor corner office in the PCAOB headquarters on Farragut Square in Washington, D.C. Doty told the SEC’s Croteau that he was carrying water for the Big Four, according to a person close to Doty and Croteau. Croteau and his staff stormed out.

In a subsequent meeting, Beswick urged Doty to focus on less-controversial rules. Doty told Beswick that he was so biased in favor of the accounting industry that he had no business serving as chief accountant and that he should resign, according to a person briefed on the meeting.

Beswick has since resumed his partnership at Ernst & Young….

And it goes on…
I am quoted in the article based on a piece I wrote for Forbes right after Doty’s appointment at Chairman.  Ironically Levinson chose to quote me being critical of Doty’s appointment, based on his previous experience at law firm Baker Botts defending George Bush, Halliburton and Deloitte.  But over time Doty has proved himself to me to be an advocate for the investor and a reform-minded regulator. That attitude aligns with everything I have written or said in the last nine years since I started writing about the Big Four.
One other interesting tidbit in the Levinson piece worth noting is related to the Center for Audit Quality or CAQ, an arm of the AICPA, the industry trade association.
The industry began mobilizing against Doty. At a meeting of a PCAOB advisory group at the Center for Audit Quality, an accounting industry lobby group, representatives of several big firms tore into him.

“He’s beating up on our profession, this has to stop,” one firm representative complained, according to a person present at the meeting.

I have said more than once that if the Big Four and next tier firms wanted a private place to discuss their business and share information about audit clients, lawsuits against them, consulting activities, tenders and pricing, university grad starting salaries and partner compensation, and regulatory strategy the CAQ would be good cover for it.  This anecdote tells me that my concerns, outlined in this post, are not exaggerated and could be worth another look by the Department of Justice’s anti-trust team.
One instance I documented where the firms have also worked together to fight against a regulator was when the SEC brought a complaint against the Chinese member firms for withholding workpapers in investigations of Chinese frauds.

The China Big Four (plus one, the former BDO affiliate, Dahua) presented their case via the same expert witness, Xin Tang, Associate Professor of the Law School of Tsinghua University in Beijing, China. Mr. Tang testified about 1) which Chinese laws, if any, the firms may violate if they provide audit work papers to the US regulator without going through the Chinese regulators; 2) what type of sanctions and liabilities, if any, the firms will encounter if they violate these Chinese laws; and 3) how the US regulator may obtain the audit work papers under Chinese law.

Unfortunately, the court redacted Mr. Tang’s testimony so we don’t know what defenses he offered on behalf of the firms…

All five firms also used the same small local Chinese law firm, Century-Link, to prepare the legal opinion—looks like it’s one letter they all photocopied— that supported their refusal to affirm the requirement to cooperate with regulatory authorities when they first registered with the PCAOB between 2004-2006. Law firm Linklaters is also a common on the ground go-to firm to support the firms on conference calls with US regulators and other counseling.

All of the defendants in the SEC’s action, the Big Four in China and BDO in China, also used former SEC Commissioner and head of private consulting firm Patomak Partners Paul Atkins as an expert witness.  Unfortunately for them he was unpersuasive in his economic argument for not sanctioning the firms.

In addition to emphasizing fear of Chinese regulators personal and professional sanctions for defying “state secrecy” laws, the Big Four plus one defended “flouting” US regulators’ authority with an economic argument.

Judge Elliot was not persuaded.

In fact, the judge basically dismissed former SEC Commissioner Paul Atkin’s expert testimony about “the Commission’s current and historical efforts to attract foreign private issuers to U.S. markets and to otherwise facilitate capital formation; the Commission’s implementation of Sarbanes-Oxley, including approving PCAOB rules related to non U.S. accounting firms; the Commission’s historical approach to the use of memoranda of understanding to attempt to resolve international conflict-of-law issues; the significance of the recently executed MOUEC between the PCAOB, CSRC, and MOF; the inconsistency of this proceeding with the Commission’s historical approach…”

Other than his opinion regarding the effect of sanctions, Atkins’ report and testimony were entirely irrelevant.

Atkins name came up again recently when another SEC Commissioner, Dan Gallagher, announced he’d joined Patomak Partners after leaving the Commission.

In the Wall Street Journal article, Atkins defends against “revolving door” accusations:

Obviously, that is not true at all.

Jim Doty is still on the job and told Patrick Temple-West of Politico in a recent interview that he plans to stay.

The Washington DC cognoscenti are divided about how that might happen.  I am sure he will stay too, for now.  But it’s a fifty-fifty bet whether it’s going to be because Mary Jo White actually reappoints him or if she just lets him squirm in limbo, neither appointing him nor anyone else in the next year, until both President Obama’s term is up and she is asked to step down by Obama’s successor.



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