-
Investors want earlier warning of risks to stock values
- Rules for vetting corporate crimes set for update
- Ethics & Corruption (
Bloomberg Law subscription)
Years after
The end appears in sight. The US audit board has pledged to modernize requirements dating back decades that spell out how auditors should consider the risk that public company clients violated a law or regulation when vetting their earnings and balance sheets.
Investors want the changes to shed more light on corporate crimes. Accountants and lawyers, meanwhile, say the audit requirements should reflect modern governance practices like ethics hotlines and risk assessments—safety nets that didn't exist in the 1980s when the rule was written.
"They are more important than ever," said
Material Impact
The
The standard that the PCAOB picked up dates to 1988. It responded to fallout from corporate bribery scandals linked to Watergate, but misses the impact of subsequent securities law changes, whistleblower programs, and updates to other PCAOB rules.
The standard makes clear that it's not up to auditors to determine whether a crime has been committed. Instead, the auditors' job is to consider whether the possible cost of misdeeds like an environmental spill or sexual misconduct involving a top executive would materially impact the financial statements. But the rule states that often those financial statement ramifications are indirect.
"We need a fraud standard and an enhanced fraud standard because there's so many ways to commit fraud today," said
Expectation Gap
The rules don't go far enough to capture serious internal failures like high-pressure sales tactics at Wells Fargo or emissions cheating by automakers. And investors have asked for tougher, clearer rules that would warn them sooner about legal risks that could threaten the value of their shares.
The bank admitted in a 2020 agreement with the
The bank's auditor,
But to investors, the bank's actions had a material impact on the value of their shares, exposing a gulf between shareholder expectations of auditors and the illegal acts standard.
"It says, 'Here's what we don't have to do.' It doesn't say anything about, 'They've got to consider the impact of events like that'," said
Turner and other investor advocates previously urged the board to require auditors to proactively search for possible law-breaking and to take specific steps to assess any financial statement fallout when they uncover misbehavior. Auditors, they say, also should have to report whether or not they learned of any law violations during the course of the audit.
The suggestions borrow from similar but more modern standards that apply to federal government financial audits and business audits conducted internationally, Turner said.
The board researched possible updates to the rule in the wake of the Wells Fargo accounts scandal. But those efforts were scuttled following a leadership overhaul in 2017.
Under new leadership once again, the board earlier this year added a project to its expansive rule-writing agenda to revise the outdated measure, sometimes referred to as non-compliance with laws and regulations. A draft of possible changes is expected in 2023, according to the PCAOB's fall agenda update.
Out of Date
The list of possible crimes and regulatory violations that auditors may encounter while combing through corporate records includes bribes, federal banking law violations, price fixing, and cybersecurity breaches. How corporate managers and their auditors respond to such risks has evolved over time.
"All those things can have a dramatic impact on the reputation and the financial performance of a particular stock. Maybe that's always been the case, but I think we have a greater appreciation for how those kinds of events can be material," said
A pair of significant securities law changes already have reshaped how corporate leaders and their outside auditors respond to legal violations.
Corporate managers now have to identify and disclose any potential illegal acts to the auditor. That includes conversations between company lawyers and its auditors, which are more robust than they once were, said Wood, who believes the audit rule continues to work well.
Among the changes over the last three decades, a 1995 litigation reform law requires auditors to report their clients to the
And the 2002 Sarbanes-Oxley Act, which created the PCAOB, tasked corporate directors with overseeing the audit and for ensuring reliable financial reporting. Among other key reforms, that law also ushered in a new era of reporting controls that provided greater confidence in corporate accounting.
Whistleblower programs and chief compliance officers also weren't mainstays of corporate operations in the 1980s, said Richards of
The PCAOB has an opportunity to improve audits involving possible crimes and other legal breeches by clarifying how auditors should incorporate those same legal and governance changes into their work, he said.
Emerging Front for Fraud
Another way the rule may come into play is through new fraud risks stemming from proposed
"People don't think you can have fraud to meet environmental regulations. You don't have to go very far back to look at
"What gets measured, gets done," he said, "and it also gets gamed."
Originally Published by
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
12th Floor
DC 20006
Tel: 202797 1111
URL: ankura.com
© Mondaq Ltd, 2022 - Tel. +44 (0)20 8544 8300 - http://www.mondaq.com, source