The White House recently unveiled its federal budget proposal and, as expected, funding for regulatory agencies is on the chopping block once again. Under the proposal, the Consumer Financial Protection Bureau ("CFPB") would see its budget trimmed by $110 million in 2021 while the Commodity Futures Trading Commission ("CFTC") faces a potential budget cut of more than 20 percent.
Yet, perhaps the most surprising feature of the proposed budget is what it leaves out. The administration has proposed eliminating the Public Company Accounting Oversight Board ("PCAOB") and reassigning its responsibilities to the Securities and Exchange Commission ("SEC") beginning in 2022. The White House estimates the move would save the government $57 million in its first year and up to $580 million by 2030 by reducing "regulatory ambiguity and duplicative statutory authorities." But doing away with the PCAOB will weaken the policing of auditing firms and ignores the improvements made in accounting standards and auditing quality.
Congress created the PCAOB after several high-profile accounting scandals resulted in the collapses of large public corporations and the criminal prosecution of some of their executives. Established by the Sarbanes-Oxley Act of 2002 ("SOX"), the PCAOB is tasked with inspecting auditing firms and their reports, setting auditing standards and enforcing compliance with SOX itself. The SEC, however, still maintains the final say on its operations even though the PCAOB is an independent regulatory body. The SEC appoints members to its governing board, approves its budget and reviews appeals of its inspection reports and disciplinary orders.
Congress did not enact SOX to create ambiguities and redundancies in the regulation of the financial markets. It was born out of a perceived need to enhance the integrity of the audit process and the reliability of audit reports on issuers' financial statements. In that regard, the PCAOB has been successful and its mission remains critical to investor confidence.
Much of the recent progress in the auditing industry may be attributed to having a dedicated regulator with a singular focus on accounting standards and practices. The financial markets have benefited from the transparency and accuracy in the auditing of publicly traded companies that the PCAOB has demanded. Eliminating the PCAOB threatens to undo that progress and dilute the oversight of audit firms. Before the PCAOB existed, the job of overseeing audit firms originally belonged to the SEC, though its resources and enforcement objectives have generally prioritized exposing others forms of abuse and misconduct in the financial markets. The enforcement of uniform and sound accounting practices, however, is equally important to the SEC's overall mission of market integrity and investor protection. As financial markets become more sophisticated, particularly with the growth of asset-based securities, reliable accounting methods are becoming more important to safeguard the investing public.
Ultimately, the issue comes down to resources. Asking the SEC to monitor audit firms is not a question of whether the SEC can do it but, rather, whether it can do so effectively and with an acceptable degree of scrutiny. A good number of the PCAOB's enforcement staff and attorneys are former auditors and forensic accountants who are proficient in auditing practice and procedures and possess a level of expertise that may exceed that of the SEC. Indeed, many have pointed out that it was this lack of proficiency among the SEC staff that demonstrated the need for a specialized regulator in the first place. It is, therefore, rash to assume that the SEC can resume its role as the audit industry's watchdog in addition to being the capital markets' chief regulator.
This is an important question, especially when considering the amount of work that comes with patrolling non-U.S. firms that audit or play a substantial role in the audit of U.S. issuers, brokers and dealers. The financial markets are more integrated and more globally oriented than they were two decades ago. Regulating the financial markets does not stop at the U.S. borders. The job is becoming increasingly international, particularly in developing markets where the regulatory infrastructure is weaker and fraud can be more difficult to detect. Independent oversight of audit reports, therefore, is essential to efficient and transparent global capital markets.
It would be a challenge for the SEC, which has its own cross-border initiatives, to handle this additional responsibility on top of its existing enforcement objectives in the United States. In its supporting role as the U.S. audit regulator, the PCAOB is better positioned to work with its foreign counterparts to inspect the reports of non-U.S. firms for U.S.-listed companies to ensure accurate and comprehensive financial statements. Oddly, the White House's proposal comes at a time when other governments are moving in the opposite direction and reinforcing their efforts to regulate the audit industry. The United Kingdom, for example, has announced a significant overhaul of its regulatory regime with plans to merge the Financial Reporting Council ("FRC") – the U.K. version of the PCAOB – into a new and larger regulatory body to be known as the Audit, Reporting and Governance Authority. The makeover comes with a commitment by the FRC to increase its audit examinations by 27 percent in its next fiscal year and expand its monitoring to smaller audit firms beyond the Big Four accounting firms. The FRC plans to support this campaign by hiring additional lawyers and forensic accountants, increasing the total headcount by 100 by the end of March 2021. The proposal to phase out the PCAOB, therefore, is unwelcome news as a growing global economy demands more coordination and cooperation among government regulators.
Of course, it remains to be seen whether the White House's proposal will spell the end for the PCAOB. Doing so would require amending SOX and that seems unlikely with a Democrat-controlled House. Politics aside, phasing out the PCAOB runs the risk of leaving the financial markets more susceptible to accounting fraud and misconduct. The SEC may not have the expertise to take the PCAOB's place and, even though the SEC's total outlays are set to increase through 2025 by $78 million, it is unclear how much of that increased funding would be dedicated to audit inspection and enforcement. Of course, the PCAOB as it exists now is not without its faults, and there is certainly more the SEC and PCAOB can do to avoid overlap. One suggestion would be to let the PCAOB continue promulgating accounting standards and conducting inspections, but letting the SEC take the lead on enforcement actions at the outset. In the end, investors rely on accurate and verifiable financial information to make informed investment decisions. That is the PCAOB's ultimate goal and it is something worth preserving.
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