On Friday, the SEC announced that it had "removed" William D. Duhnke III from the PCAOB and designated Duane M. DesParte to serve as Acting Chair, effective Friday. Duhnke has been serving as Chair since January 2018. The SEC also announced that it intends to seek candidates to fill all five board positions on the PCAOB. In the press release, SEC Chair Gary Gensler said that the "PCAOB has an opportunity to live up to Congress's vision in the Sarbanes-Oxley Act..I look forward to working with my fellow commissioners, Acting Chair DesParte, and the staff of the PCAOB to set it on a path to better protect investors by ensuring that public company audits are informative, accurate, and independent." What's it all about?
While the vote tally was not released, in light of their joint statement, it's evident that Commissioners Hester Peirce and Elad Roisman voted against the action. Their statement objected not just to the removal of Duhnke, but also to the intent expressed to replace all five PCAOB members, including members whose terms have not yet expired:
"We have serious concerns about the hasty and truncated decision-making process underlying this action. Although the Commission has the authority to remove PCAOB members from their posts without cause, in all of our actions, we should act with fair process, fully-informed deliberation, and equanimity, none of which characterized the Commission's actions here. Instead the Commission has proceeded in an unprecedented manner that is unmoored from any practical standard that could be meaningfully applied in the future. We are unaware of any similar action by the Commission in connection with its oversight of the PCAOB. These actions set a troubling precedent for the Commission's ongoing oversight of the PCAOB and for the appointment process, including with respect to attracting well-qualified people who want to serve. A future in which PCAOB members are replaced with every change in administration would run counter to the Sarbanes Oxley Act's establishment of staggered terms for Board members, inject instability at the PCAOB, and undermine the PCAOB's important mission by suggesting that it is subject to the vicissitudes of politics."
And the top Republican on the House Financial Services Committee, Patrick McHenry, released a statement characterizing the action as
"unprecedented and a blatant politicization of an independent PCAOB..Chairman Gensler appears to be treating the PCAOB like a political football beholden to a left-wing Democrat Commission that panders to progressives like Elizabeth Warren. If this is the case, it's unclear why the PCAOB should continue to exist as a separate entity from the SEC going forward. I have a lot of questions about how and why the Chair took this action, including whether or not Commissioner Lee recused herself from a Commission vote given her conflicts of interest, and I will be holding Mr. Gensler accountable for this decision."
There's no official word on what happened here, but that hasn't stopped anyone from speculating. Let's put a big "allegedly" in front of the entire discussion below, but here's what reporters are saying. Politico characterized the termination as "a victory" for progressives "after they called for the audit watchdog's leadership to be fired.. The progressives warned that the PCAOB, which was established after the Enron and WorldCom accounting scandals, was failing to crack down on corporate wrongdoing and was captured by industry." Reuters said that "Duhnke's ouster is a warning shot by the new SEC chair Gary Gensler." The PCAOB, Reuters continued, "has long been criticized by Democrats for being toothless," adding that two Senators "last month pressed the SEC to immediately replace the board, which they said has fallen down on its job of overseeing audit firms meant to keep publicly-traded companies in check." In addition, Reuters reported that the "PCAOB has also come under criticism by hawks who wanted it to take a tougher stance on Chinese auditors of U.S.-listed Chinese companies which have generally evaded U.S. oversight." The WSJ also cited the letter from the two Senators, which contended that the prior administration had taken "deliberate steps to erode the PCAOB's independence and expertise, leading the watchdog to, for example, weaken auditor-independence rules and exclude investors from participating in its policy-making process." According to Bloomberg, "Duhnke's critics argued that he had mismanaged the regulator and was too friendly to accounting firms.. Gensler's decision will likely inflame partisan squabbling about the PCAOB."
Accounting Today agreed that the PCAOB has "come under criticism," but attributed the criticism to "ending meetings of its Investor Advisory Group and Standing Advisory Group and holding few open meetings during Duhnke's tenure. Duhnke became chairman in January 2018 and, over the next two years, the rest of the other board members and much of the top staff at the PCAOB were gone, including a board member who was replaced by a White House aide.. The PCAOB also overhauled its standard-setting agenda, strategic plan, and audit firm inspection process in keeping with the deregulatory agenda" of the prior administration and then-SEC Chair Jay Clayton. CFO.com similarly attributed the firing to complaints from advisors: "The move by Gensler is not a surprise. As CFO reported on May 20, former members of the PCAOB's Investor Advisory Group (IAG) sent a letter to Gensler and several Democratic politicians in mid-April calling for Duhnke III's removal. The letter accused the PCAOB of 'drifting away' from its 'core mission of investor protection' in the past four years and said urgent action was needed to 'restore investor trust and confidence in the quality of public company audits in the United States.' The letter also said, 'Given their track record, we do not believe the current PCAOB Board members are up to the task of re-focusing the PCAOB on its core mission because they are responsible for the dramatic shift away from what investors expect.'" According to CFODive, "Duhnke has been the subject of criticism by investor advocates and others, including former PCAOB advisors, for taking steps they viewed as increasing risks. 'These failures [by PCAOB] increase risks to our financial system and require immediate attention,' the former advisors said in a letter to the SEC in April. Critics also took issue with a proposal last year to fold PCAOB into the SEC and make its function part of the SEC's mission." The WSJ reported that Duhnke had recently "faced criticism from investors who said the PCAOB didn't adequately incorporate their feedback into its work. Under Mr. Duhnke, the watchdog in 2018 stopped holding meetings of two groups that consulted investors, citing what the board described as the meetings' ineffectiveness. It still conducts other events with investors though."
The PCAOB has been plagued by troubles in the last few years, including the 2017 leaking scandal, which, in 2018, led the SEC to file charges against six CPAs, including former staffers at the PCAOB and former partners of KPMG, arising out of "their participation in a scheme to misappropriate and use confidential information relating to the PCAOB's planned inspections of KPMG." Essentially, the former PCAOB staffers were alleged to have leaked to KPMG the plans for PCAOB inspections of KPMG-"literally stealing the exam." (See this PubCo post.) The same scheme led the U.S. Attorney's Office for the SDNY to file criminal charges against the former staffers, and some have actually been sentenced to prison.
Following that scandal, as reported by the WSJ in October 2019, the PCAOB "slowed its work amid board infighting, multiple senior staff departures, and allegations that the chairman has created a 'sense of fear,' according to a whistleblower letter and people familiar with the situation..The regulator has issued 27% fewer audit-inspection reports this year, board data show, as senior staff positions remain unfilled for months." What's more, that same whistleblower complaint- submitted by a group of employees to the board in May and to the SEC in August-precipitated the appointment of Harvey Pitt, former SEC Chair, to review "PCAOB corporate governance."
A PCAOB spokesperson told the WSJ that, following the eruption of the leaking scandal in 2017, the board "undertook a sweeping assessment in 2018 of its operations and has been working toward 'a series of transformation initiatives to address systemic issues that exist across the organization.'" And, after the SEC became aware of the leak of confidential information, in December 2017, it replaced the PCAOB's entire board. But, the WSJ reported, shortly after arriving, the new Chair "began pushing out longtime senior executives, according to the whistleblower letter and people familiar with the matter. The whistleblower letter said the regulator 'is permeated by a sense of fear,' due to 'the numerous terminations . [some] driven by retaliation.'" The new Chair also "clashed with other board members over hiring choices, the people familiar with the matter said."
Then, although PCAOB members have historically been reappointed for new terms, one board member, Kathleen Hamm, wasn't reappointed to the board, support from the Council of Institutional Investors notwithstanding. She was replaced on the PCAOB by a White House staffer. In addition, Clayton announced that Commissioner Hester Peirce would be leading the SEC's "coordination efforts with the Board of the PCAOB, in coordination with the SEC's Chief Accountant Sagar Teotia and the Office of the Chief Accountant." While, at first glance, it all sounds fairly anodyne, reports surfaced that Hamm had had disagreements with the PCAOB Chair on policy matters.
In addition, Bloomberg Financial Accounting News reported, in 2019, two Democrats on the Senate Banking Committee sent a letter to Clayton suggesting, in light of the problems cited by the whistleblower in the WSJ article, that SEC oversight of the PCAOB showed "questionable judgment and an alarming lack of transparency." The Senators also questioned the appointment of Peirce and sought information on the role she would be playing. They characterized her appointment as "troubling" because it "raises the potential of undue influence," given that the entire SEC is supposed to oversee the PCAOB, not a single coordinating commissioner, and that Peirce was a "longtime colleague" of the PCAOB Chair.
And, if that weren't enough, former SEC Chair Arthur Levitt penned an op-ed in the NYT in 2019, charging that "what is happening at the Public Company Accounting Oversight Board-the body tasked with auditing the auditors-should alarm the investing public and anyone who cares about objective and experienced oversight of the audit profession." His concern was an outgrowth of the change in members of the board (which he appears to view as politically motivated), as well as the appointment of Peirce, whom he termed "a regulation skeptic, [to be] in charge of coordination efforts with the board-a signal that the S.E.C. is seeking to pull it into its efforts to weaken requirements for audits of internal controls at public companies." (See this PubCo post.) The PCAOB has a critical role to play; yet, citing the WSJ article, he contended that it " is doing less oversight and inspection work than it once did, and key positions at the agency are unfilled. Morale is reportedly low." In his view, what is "at risk isn't a specific regulatory function of the P.C.A.O.B.; it's the independence and the credibility of the board and its staff as a whole." (See this PubCo post.)
Finally, as reported by Thomson-Reuters, a lawsuit was filed last month by a senior officer of the PCAOB against the regulator and Duhnke, charging unlawful termination on the basis of race. The litigation accused Duhnke of perpetrating "a xenophobic and racist campaign" against her, including allegations that he made racist comments in her presence, remarked about "her Chinese ancestry and birth overseas," regularly referred "to the COVID-19 pandemic as 'kung flu' and the 'Chinese flu' in her presence," and mocked her for wearing a mask in the office. The PCAOB has denied the allegations, according to Law.com, contending that the PCAOB officer was fired over "internal complaints about her conduct and for questions about the necessity of certain travel. "
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