As published in MicoCap Review Magazine
Auditing the Auditors
By: Corey Fischer
Managing Partner, Weinberg & Company P.A.
Your company’s outside auditor just got sacked by the Securities and Exchange Commission (SEC) or the Public Company Accounting Oversight Board (PCAOB). It’s certainly bad news for your auditor, but it’s equally bad news for your company as well.
Aside from scrambling to find a replacement auditor, your new auditor will not be able to just pick up the ball and continue forward. They will be required to conduct a look-back audit of your company financials spanning the past year or two. Meantime, your company will be tainted in the eyes of all who read your financial statements including: lenders, shareholders and potential investors.
Farfetched? No, it’s happening with increasing frequency, especially to the accounting firms that service micro-cap companies.
Historically, the Accounting profession was a self-governed group—setting its own professional standards and practices and taking disciplinary action when necessary against its fellow professionals.
That all changed in the wake of the Enron debacle with the enactment of the Sarbanes-Oxley Act of 2002. The Act included the creation of the PCAOB—a private-sector, nonprofit corporation to oversee the audits of public companies and other issuers in order to protect the interests of investors and assure the preparation of informative, accurate and independent audit reports. The PCAOB has four primary functions in overseeing these auditors: registration, inspection, standard setting and enforcement.
But don’t let the “private-sector, nonprofit corporation” title fool you. The PCAOB is very much a federal regulator with sharp teeth; it is closely connected to the U.S. Securities and Exchange Commission. For example, the PCAOB’s five Board members are appointed by the SEC and its very powers, as well as its annual budget, must be approved by the SEC.
It should also be noted that in addition to the PCAOB’s vast powers, the SEC also has stepped up its oversight over those accounting firms that service public companies. The SEC may directly initiate an enforcement action against a company, company management, and its auditors. SEC enforcements are typically more swift, immediate and punitive.
One of the PCAOB’s most important powers allows it to conduct periodic inspections of PCAOB-registered public accounting firms. Think of these inspections as an on-site audit, where PCAOB auditors thoroughly review the quality and practices of an accounting firm’s audit work. The inspection report oftentimes will cite criticisms and defects found in the accounting firm’s audit work and quality control systems. Eventually the report is made public for all to see. A PCAOB report with many listed deficiencies may be a great indicator of impending PCAOB or SEC enforcement actions.
The increasing number of accounting “restatements” by public companies, along with the higher number of deficiencies found during inspections, has provided impetus and justification for the SEC and the PCAOB to continually raise the bar and become more punitive. As a result, several accounting firms have fallen by the wayside—some by regulatory enforcement actions, others by discontinuing their audit practice altogether and moving to other, less scrutinized areas of accounting.
All in all, the number of auditors are declining and that decline is expected to accelerate rapidly over the next few years as regulators get even tougher. It is therefore incumbent for companies to carefully review PCAOB inspection records before they select and engage their audit firm. Don’t get blind-sighted. A little due diligence up front can avoid a major disaster later.
As the world of accounting and finance becomes more complex, accounting firms will increasingly be forced to step up, step out, or be kicked out. And that is not a bad thing.
Our free-market economy cannot survive in the absence of public confidence in the system. That confidence can only come by way of integrity, transparency and a high and enforced level of quality work.
Corey Fischer, CPA, is Firm Managing Partner of Weinberg & Company, a multi-office, PCAOB-Registered firm specializing in the audit, assurance and tax needs of micro and small cap companies. He has more than 25 years of experience, having worked with the Big 4 accounting firms, and as an SEC reporting officer for a number of NASDAQ-listed companies. He is based in Los Angeles, and is an expert in financial reporting, SEC compliance, raising debt and equity, mergers and acquisitions, and structuring accounting operations. Email: email@example.com or 310-601-2200.