We write in opposition to the hasty and opaque efforts underway to abolish the Public Company Accounting Oversight Board (PCAOB), the nonprofit organization that oversees audits of public companies and SEC-registered brokers and dealers in the United States, currently overseen by the Securities and Exchange Commission (SEC). Efforts to eliminate the PCAOB are being pursued through an unusual budgetary process, without meaningful opportunity for public comment and debate, and without any announced plan or newly appropriated resources for the SEC to take on the PCAOB’s job. We urge a careful review by the new SEC chairman of the PCAOB’s functioning and operations for the purpose of developing proposals on matters such as how the PCAOB could either be improved or effectively reorganized into the SEC. But any such review should occur before the PCAOB is abolished.
The PCAOB was created by a bipartisan and nearly unanimous vote of Congress in 2002 following a decade of deteriorating accounting and auditing outcomes for U.S. public companies. Restatements, earnings management, and fraud all rose in the period during which the audit profession’s only overseers were the SEC and a largely toothless self-regulatory body. The culmination of this deterioration was a host of accounting failures, including at Enron and WorldCom, which resulted in massive bankruptcies and investor losses. What set this era apart was that financial failures were not limited to small or under-resourced companies, but included large companies. The PCAOB was created to fix this broken system.
There is no serious debate that the PCAOB has improved the linchpin of the U.S. financial system, public company auditing. By setting standards for auditing, and by inspecting audit firms, it has augmented auditing practices and improved the reliability of financial reporting. That, in turn, has improved capital-market liquidity and lowered the cost of capital. The PCAOB’s role has not been a “fix it once” task – accounting practices and the requirements for effective auditing evolve over time, in tandem with changes in business practices, technology, and financial risks and opportunities. Nothing suggests that now is an appropriate moment for the PCAOB’s work to be brought to a sudden end.
The PCAOB also plays a vital role in protecting investors in companies cross-listed into the U.S. from countries – such as the People’s Republic of China (PRC) – that historically had weak auditors and posed acute investment risks. Congress unanimously approved the Holding Foreign Companies Accountable Act (HFCAA) in 2020, a bipartisan law to improve foreign accounting and auditing, through the mechanism of PCAOB oversight of foreign auditors, backed by the threat of delisting. The HFCAA has worked. In 2022, the PRC accepted PCAOB inspections of PRC auditors as the first and only regulatory body with such access. To abandon the PCAOB now would release the PRC from its treaty commitments. In a moment of increased tension between the PRC and the U.S., such a step would likely unwind the HFCAA’s accomplishments and expose U.S. investors to heightened risks of fraud and abuse.
We do not mean to suggest the PCAOB has been perfect. Some believe it has overly focused on small audit firms, and others believe it has not been sufficiently transparent, although the first major change in the auditor’s opinion letter in decades – the disclosure of “critical audit matters” – was successfully introduced by the PCAOB. Nonetheless, there is a lively debate over what if any new audit standards should be adopted or how existing ones should be improved. There may well be opportunities to improve the PCAOB’s functioning, to reduce costs or enhance outcomes, to streamline staffing, or to adjust its priorities. Its institutional design – protecting it from industry capture while also giving it ample access to expertise and an appropriately diverse array of constituencies (audit firms, companies, and investors of varied types) – could be adjusted, too, if the case could be made that doing so would likely improve outcomes or reduce net costs of its operation.
Nonetheless, the case for dramatically reorganizing it, much less abolishing it, has not been made. Neither has the case for combining it with the SEC. The SEC already has a wide array of competing priorities, a complex structure, and a diverse and large staff. Nor does the SEC have the consultation mechanisms to inform its oversight of auditing and protect against capture by a highly concentrated and well-resourced industry.
Abolishing the PCAOB will not accomplish any deficit reduction or budget savings. Contrary to apparent misunderstandings, the PCAOB’s resources are not derived from the U.S. Treasury or taxpayers, but from a separate fee stream, the accounting support fees paid by audited companies. Notably, those fees would disappear if the PCAOB were abolished or folded into the SEC, as the Congressional Budget Office (CBO) has acknowledged. The CBO has also speculated that eliminating those fees might increase taxes paid to the United States by increasing company revenues. But eliminating audit oversight could also increase investment losses, which would reduce tax revenues. We are confident that no net budget benefit can be confidently predicted from the abolishment of the PCAOB.
Indeed, part of the point of the PCAOB’s design was to try to insulate its funding – and the reliability of U.S. auditing of public companies – from the vagaries of the annual federal budget process. Combining the PCAOB into the SEC would expose the auditing oversight functions of the SEC to risks of industry capture or budgetary shortfall. Moreover, combining the PCAOB into the SEC would amount to giving the SEC an unfunded mandate to take on substantial and difficult tasks. We note that last year, the PCAOB reported that its staff inspected over 230 audit firms and reviewed over 900 audit engagements, including in mainland China and Hong Kong.
Successful reorganizations are daunting, take time, and generate transition costs. Even if the case for combining the PCAOB into the SEC could be made, the SEC has not been given resources or time to navigate that process. A transition would require the SEC to develop and implement a full reform agenda for auditing, with the public comments that characterize the PCAOB’s procedures and to maintain the PCAOB’s extensive inspections and specialized disciplinary actions. In addition, abolishing the PCAOB would require the SEC to hire numerous new staff members to carry out these functions. It currently lacks funding to do that. Although much of the PCAOB staff would likely be able to fill this role, the budget bill does not contemplate a process for recruiting and onboarding staff of the PCAOB into the SEC or address the costs of doing so. At a minimum, taking on the new obligations would take time and distract and reduce the ability of the SEC to pursue its vital existing tasks of overseeing U.S. capital markets. Before attempting to work a significant regulatory reorganization through the budgetary process, policymakers should allow the SEC time to develop and – after normal public input required by administrative law – finalize a plan for any such reorganization.
We strongly urge that the future of the PCAOB be the subject of a thoughtful and considered analysis rather than a hasty and poorly reasoned budget decision by Congress.
This post comes to us from The Shadow SEC, whose members are professors John Coates at Harvard Law School, John C. Coffee, Jr. at Columbia Law School, James D. Cox at Duke University School of Law, Jill E. Fisch at the University of Pennsylvania Law School, Merritt B. Fox at Columbia Law School, and Joel Seligman at Washington University School of Law.