Take one little known US regulator. Add a technical, highly concentrated industry and a Republican chair bent on deregulation. The result is today’s Public Company Accounting Oversight Board, a defanged watchdog in disarray.
By the time the chair, William Duhnke, was removed last Friday, many senior staff had been pushed out and the accounting watchdog had hired Duhnke’s political patron’s granddaughter in a junior role. Accused in a whistleblower letter in 2019 of instilling a “sense of fear”, Duhnke was also sued by the former chief risk officer alleging wrongful termination and racial discrimination. Sue Lee says he referred to coronavirus as “kung flu” and compared her wearing of masks to the Chinese Communist party. Duhnke has defended his leadership and countersued, claiming Lee was fired for cause over improper business travel, which she denies.
This list of failures would be almost laughable if the results were not so tragic. Robust auditing is critical for preventing misbehaviour, as decades of scandals such as those at Enron, Carillion, Wirecard and Luckin Coffee make clear. But the economics of the sector conspire against protecting investors. Paid by companies and under pressure to work quickly, auditors face temptations to cut corners and make nice to the executives who hire them.
Tough oversight is needed to stiffen auditors’ backbones and restrain the dominant Big Four firms — EY, KPMG, PwC and Deloitte. After learning this the hard way with Enron and the 2002 corporate collapses, the US set up the PCAOB inside the Securities and Exchange Commission.
The body was far from perfect. Even though, or perhaps because, board jobs are among the best paid in Washington ($673,000 for the chair, $547,00 for the rest), the PCAOB seemed to struggle to find strong members who were neither industry shills nor political hacks. Rulemaking efforts moved at a glacial pace. But staff inspections of corporate audits and enforcement cases set a template that other countries emulated. Under its watch, the US has been largely spared huge accounting scandals.
Then Donald Trump’s administration cut the inspection budget and tried to abolish the board. A staff member illegally tipped off KPMG about pending inspections. Enforcement actions fell from 43 in 2016 to 13 last year, and the board watered down auditor independence rules without public comment.
Now Democrats are trying to give the watchdog back its teeth. Cheered on by progressive lawmakers, SEC chair Gary Gensler last week pushed Duhnke out and promised to fill all five board seats with new people. The move is overdue, with concerns growing that frothy equity markets are hiding all sorts of accounting sins. “Getting back into the business of rulemaking and standard setting is vital,” says Dennis Kelleher of the Better Markets investor group. “People are overly aggressive when they know the cop is off the beat.”
Tossing out the entire board is not an ideal solution. It will, as the two Republican SEC commissioners complained last week, further politicise the watchdog and “inject instability.”
But desperate times call for desperate measures. Republican misrule is to blame for the state of the PCAOB. Board members originally had fixed terms, but the conservative majority on the Supreme Court ruled they were unconstitutional. Trump’s SEC chair Jay Clayton swept out the entire board in 2017. He later put two longtime Big Four partners on instead and refused to reappoint a respected Democratic member.
“If Gensler wants to use the PCAOB as effectively as it can be used, he’s got to clean house. It’s become a honeypot because it pays so well,” says Arthur Levitt, a former SEC chair. “It’s a body that can easily go awry.”
Gensler must also reduce the industry’s grip on the PCAOB. The last round of inspections, by a much denuded division, concluded that 22 per cent of US audits by the Big Four were “deficient” and the figure rose to 30 per cent at PwC. What would a stronger watchdog find?
When choosing industry-linked board members, Gensler should eschew Big Four lifers. If he’s worried about continuity, he could reappoint Kathleen Hamm, the Democrat Clayton dumped.
Gensler also needs to boost the watchdog’s stature. Previous chairs put the board under the supervision of the SEC’s chief accountant, an office that has recently run a revolving door with the Big Four. That gave them too much say over its activities. The PCAOB should report directly to the commission.
Accounting is one of those knotty subjects where it’s tempting to leave the details to the experts. We can’t afford to do that any more.
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