The Evolving Role of Investor Protection at the PCAOB (Part II of II)

by J. Robert Brown, Jr.

These remarks have been edited for length and are being published in two parts. The following post is Part II of J. Robert Brown, Jr.’s prepared remarks delivered on November 6, 2020 at the 50th World Continuous Auditing & Reporting Symposium. As Mr. Brown noted at the beginning of his remarks, the views he expressed therein are his own and do not necessarily reflect the views of his fellow Board members or the staff of the PCAOB.

Accountability and Public Input

With respect to the PCAOB’s mission, transparency is necessary but not sufficient. Transparency is no guarantee of actual participation. For this to occur, the PCAOB must put in place structures that ensure investors have clear, consistent and recognized avenues for input. In doing so, the PCAOB should ensure that input is sought from underrepresented segments of the investor community.

Current Mechanisms

The PCAOB has traditionally sought investor input in three basic ways: notice and comment with respect to proposed standards; direct outreach; and advisory groups.

Advisory groups have been an important source of investor input and views, particularly with the creation of the Investor Advisory Group, an advisory group consisting entirely of investors and those familiar with the investor community.[1] Members of the advisory groups have been given multiple year terms[2] that allowed for the development of an increased understanding of the activities of the PCAOB and the audit process. In addition, the advisory groups relied on open meetings, providing the public with insight into the activities of the PCAOB and the issues raised by investors at those meetings.

These groups were governed by charters adopted by the PCAOB.[3] The charters gave the PCAOB plenary control over the frequency of the meetings, the agenda, and any follow-through. They can be changed without notice to, or input from, the public. The PCAOB could, if it wanted, dispense with meetings in their entirety.

This, in fact, has occurred. Advisory groups have not met since November 2018, a hiatus of two years and counting. Given this dearth of meetings, there was no opportunity for the advisory groups, particularly the investors on these advisory groups, to publicly weigh in on recent changes to the standard setting agenda despite their impact on issues identified by investors as important.[4]

The PCAOB also permits investors to participate by providing an opportunity to comment on proposed standards. Merely allowing for investor participation does not ensure that participation will in fact occur. In the past, the PCAOB has engaged in outreach and taken into account investor input when issuing standards or considering changes to the standard setting agenda. The discretionary nature of these practices means that they can be discontinued at any time.[5]

Reforms

After almost two decades of experience, it’s clear that the efforts to obtain adequate investor input and advice needs to be strengthened. The PCAOB should enhance existing avenues, add additional ones, and make them mandatory through inclusion in the bylaws and rules. This would transform them into an obligation rather than a choice.

In setting up the relevant structures, the PCAOB should also take cues from Congress. Congress has recognized that agencies charged with protecting investors can sometimes benefit from structural changes designed to enhance that mission. Where Congress has stepped in, the PCAOB should implement these requirements, altered appropriately to address any unique attributes of the PCAOB.

1. Advisory Groups and Investor Advocate

With respect to advisory groups, the PCAOB approach should rely on the model adopted by Congress for use at the SEC.

In the Dodd-Frank Act, Congress instructed the SEC to establish an investor advisory committee.[6] In requiring that the SEC do so, Congress set out a clear structure. The committee was given a broad purpose,[7] a specified size, and mandatory representation for certain important groups or organizations.[8] The statute specified the terms of office and a minimum frequency of meetings.[9] The officers, including the chair, were to be elected by the committee.

Perhaps most significantly, the committee received the authority to issue recommendations and the Commission was obligated to respond.[10] The meetings were held in public with a webcast posted for anyone to review.[11] The investor advisory committee also formed subcommittees to discuss and advance recommendations in between meetings of the entire committee.[12]

Dodd-Frank did more than mandate an investor advisory committee. Congress also created the Office of the Investor Advocate.[13] The Investor Advocate must have experience “in advocating for the interests of investors in securities and investor protection issues, from the perspective of investors.”[14] The provision addressed compensation, reporting lines, staffing, and the functions of the office.[15] Some degree of transparency was ensured by a requirement that the office produce an annual report filed with Congress. The PCAOB would benefit from the addition of this Office.[16]

2. Notice and Comment

The PCAOB has, since inception, provided investors and the public with an opportunity to comment on proposed standards. The policy is, however, discretionary and could be set aside at any time by the Board. In addition, while providing opportunities for notice and comment, the PCAOB has never publicly committed to adherence to the requirements of the APA. The APA requires more than public notice and an opportunity for comment.

The PCAOB should do two things with respect to notice and comment.

First, the PCAOB should make it an obligation not a choice.[17] The requirement should, therefore, be included in the PCAOB’s bylaws or rules. The PCAOB can provide exceptions but they should be limited to those set out in the APA.[18]

Second, the PCAOB should agree to follow the requirements of the APA with respect to informal rulemaking. This would require the submission of memoranda to the rulemaking file whenever Board members or other staff meet with an outside organization to discuss a proposed standard.[19] Investors and the public would benefit from knowing who met with Board members and/or the staff in connection with a proposed rule or standard.

3. Right to Petition

The PCAOB should take from and adopt other provisions in the APA designed to encourage investor and public participation. In particular, the PCAOB should set up a mechanism that allows for public petitions to change standards or rules and requires the posting of any comment letters received on the petition.

This is a requirement for government agencies.[20] Market participants make extensive use of the authority at the SEC.[21] Recent petitions have addressed topics ranging from changes to require companies to report on the physical location of their significant assets,[22] to ending the Commission’s “backdoor” regulation of 12b-1 fees,[23] to the use of electronic signatures.[24] Petitions are made public and sometimes generate a substantial number of comment letters.[25]

Implementing this mechanism would be a substantial change at the PCAOB. Right now if an investor or member of the public writes to us and asks for revisions in our standards, rules, or approach, the PCAOB doesn’t make the communication (or any response) public. As a result, other investors and the public may be unaware of these views or concerns.

Implementing a public petitioning mechanism, including the posting of comment letters, would likely increase public participation. Investor views would become more accessible and potentially encourage other participants in the capital markets to submit their own comments to further the discussion.

4. Outreach and Underserved Communities

With respect to outreach, the PCAOB currently has a position devoted to outreach to all stakeholders, including audit committees, preparers, and investors. The operating divisions sometimes conduct outreach to investors in specific cases.[26]

Outreach concerning proposed standards or other policy decisions is, however, discretionary not mandatory.[27] Nor is there structural mechanism designed to ensure that outreach occurs with respect to underrepresented communities or that these communities are adequately considered in connection with the PCAOB’s advisory groups.

Congress, however, provided a way forward with respect to this issue. Dodd-Frank required that the SEC put in place an Office of Minority and Women Inclusion.[28] The purpose was to promote diversity and inclusion in the financial services industry.[29] As a regulator in the financial services industry, the PCAOB would benefit from a similar office. The office would help improve outreach by the PCAOB to underrepresented communities and to promote transparency and awareness of diversity practice within the PCAOB.

Conclusion

So let me return to where I started. This is about the evolution of the PCAOB.

Congress inserted into the DNA of the PCAOB a mission to act in the interests of investors and the public. The mission, however, came with few specifics. Execution was left for the PCAOB to determine.

In 2003, the PCAOB, in executing the mission, was writing on whole cloth. Figuring out how to incorporate investor views into the process would necessarily be a learning exercise that would evolve over time.

We’ve now had 17 years of experience and insight. Investors and the public want, and are entitled to, a level of transparency comparable to what is provided by government agencies. They also want more useful information that can be factored into investment and voting decisions. Avenues for investor input, which means input for all investors, including underrepresented communities, should be guaranteed through structural changes to our bylaws or rules.

We should implement these evolutionary steps because we know from experience that they are necessary. As Congress knew, the capital markets benefit from the public interest mission. Investor and public input increases trust in the actions of the PCAOB, the audit and, ultimately, the financial disclosure process.[30]

For Part I of this post, click here.

Footnotes

[1] See generally Investor Advisory Group, PCAOB (available at https://pcaobus.org/About/Advisory/Pages/IAG.aspx); see also Charter of the Investor Advisory Group, PCAOB (available at https://pcaobus.org/About/Advisory/Pages/Charter.aspx).

[2] Id.

[3] Id.

[4] J. Robert Brown, Jr., supra note 3.

[5] See supra notes 20-23. The PCAOB did conduct outreach in connection with the recent efforts by the Division of Economic Research and Analysis in its review of critical audit matters. See Michael J. Gurbutt, Wei-Kang Shih & Carrie von Bose, Staff White Paper: Stakeholder Outreach on the Initial Implementation of CAM Requirements, PCAOB (Oct. 2020) (available at https://pcaobus.org/EconomicAndRiskAnalysis/pir/Documents/Stakeholder-Outreach-Initial-Implementation-CAM-Requirements.pdf). ERA conducted a survey of investors and also provided an opportunity for comment. The PCAOB also has a single employee responsible for “outreach” to all stakeholders, whether audit committees, preparers and investors.

[6] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010); 15 U.S.C. § 78oo.

[7] 15 U.S.C. § 78pp(a).

[8] Id. § 78pp(b).

[9] Id. § 78pp(d).

[10] Id. § 78pp(g).

[11] See Investor Advisory Committee Meeting, U.S. Securities and Exchange Commission (May 21, 2020) (available at https://www.sec.gov/video/webcast-archive-player.shtml?document_id=iac052120).

[12] See Subcommittees of the Investor Advisory Committee, U.S. Securities and Exchange Commission (available at https://www.sec.gov/spotlight/investor-advisory-committee-2012/investor-advisory-committee-2012-subcommittees.shtml).

[13] 15 U.S.C. § 78d(g).

[14] In addition to the Office of the Investor Advocate, the SEC also has an Office of Investor Education and Advocacy. See Office of Investor Education and Advocacy, U.S. Securities and Exchange Commission (available at https://www.sec.gov/page/oieasectionlanding). The PCAOB has no similar office.

[15] 15 U.S.C. § 78d(g).

[16] We do have a structure in place to provide educational functions to audit firms. See Forums on Auditing in the Small Business Environment and Forums for Auditors of Broker-Dealers, PCAOB (available at https://pcaobus.org/News/Pages/SmallBusinessForums.aspx) (“The Forum on Auditing in the Small Business Environment is a program for representatives of the small business community to learn more about the work of the Board, specifically the PCAOB inspection process and the impact of new auditing standards. Auditors from smaller registered public accounting firms are invited to attend. The seminars, which are offered at no cost to attendees, give participants the chance to learn about and discuss PCAOB issues with Board members and staff.”).

[17] While the SEC does generally require notice and comment when approving a standard, the opportunity comes at the end of the process when most decisions are already baked into the standard. Before matters get to the SEC, the PCAOB often subjects standards to multiple iterations and multiple opportunities for comments in a lengthy process.

[18] 5 U.S.C. § 553(b)(B) (“Except when notice or hearing is required by statute, this subsection does not apply— . . .when the agency for good cause finds (and incorporates the finding and a brief statement of reasons therefor in the rules issued) that notice and public procedure thereon are impracticable, unnecessary, or contrary to the public interest.”).

[19] The SEC, for example, includes as part of the record for proposed rules a section titled “Meetings with SEC Officials” that typically references meetings with outside groups, including the identity of the attendees.

[20] See 5 U.S.C. § 555. The requirement was designed to implement a similar concept included in the U.S. Constitution. See Maeve P. Carey, Petitions for Rulemaking: An Overview, CRS, at 2 (Jan. 23, 2020) (available at https://fas.org/sgp/crs/misc/R46190.pdf) (“The APA’s petition mechanism essentially re-stated the right to petition the government established by the U.S. Constitution, which can be traced as far back as the Magna Carta and Declaration of Independence.”).

[21] Petitions for Rulemaking Submitted to the SEC, U.S. Securities and Exchange Commission (available at https://www.sec.gov/rules/petitions.shtml); see also 17 C.F.R. § 201.192.

[22] See Letter from Joseph F. Keefe, President and Julie Gorte, Senior Vice President, Impax Asset Management LLC, to the U.S. Securities and Exchange Commission, Rulemaking petition requiring companies to report on the physical location of their significant assets, Petition No. 4-763 (Jul. 9, 2020) (available at https://www.sec.gov/rules/petitions/2020/petn4-763.pdf).

[23] See Letter from Sam Kazman, Competitive Enterprise Institute; Mark Chenoweth, New Civil Liberties Alliance; Helgi C. Walker, Gibson, Dunn & Crutcher LLP; David T Bellaire, Financial Services Institute, to U.S. Securities and Exchange Commission, Rulemaking petition to end the Commission’s backdoor regulation of 12b-1 fees, Petition No. 4-761 (Apr. 29, 2020) (available at https://www.sec.gov/rules/petitions/2020/petn4-761.pdf).

[24] See Letter from Stephen E. Bochner and Richard C. Blake, Wilson Sonsini Goodrich & Rosati; David A. Bell and James D. Evans, Fenwick & West LLP; and, David G. Peinsipp and Charles S. Kim, Cooley LLP, to the U.S. Securities and Exchange Commission, Rulemaking petition requesting the Commission amend Rules 11 and 302 of Regulation S-T, as well as any other rules or forms necessary to permit such amendments to have their desired effect, at its earliest convenience to permit electronic signatures in addition to manual signatures, Petition No. 4-760 (Apr. 16, 2020) (available at https://www.sec.gov/rules/petitions/2020/petn4-760.pdf).

[25] The SEC has, for example, received a number of petitions relating to disclosure of environmental, social and governance matters, including climate change. Some have received extensive public comment. See Comments on Request for rulemaking on environmental, social, and governance (ESG) disclosure, File No. 4-730, U.S. Securities and Exchange Commission (available at https://www.sec.gov/comments/4-730/4-730.htm).

[26] Compare supra notes 17-19 with, supra notes 51-52.

[27] J. Robert Brown, Jr., supra note 3.

[28] Office of Minority and Women Inclusion, U.S. Securities and Exchange Commission (available at https://www.sec.gov/page/omwi-section-landing).

[29] Congresswoman Maxine Waters of California explained that Section 342’s objectives are to “not only give oversight to diversity, but to help the Agencies understand how to do outreach [and] how to appeal to different communities.” Stephanie Wilson & Raeann Traficante, United States: The Final Regulations For Section 342 Of Dodd-Frank Are Almost Ready…Are You?, Mondaq (Mar. 27, 2015), (available at https://www.mondaq.com/unitedstates/Finance-and-Banking/384450/The-Final-Regulations-For-Section-342-Of-Dodd-Frank-Are-Almost-ReadyAre-You).

[30] J. Robert Brown, Jr., supra note 3.

J. Robert Brown, Jr. is a Board Member of the Public Company Accounting Oversight Board. 

Disclaimer

The views, opinions and positions expressed within all posts are those of the author alone and do not represent those of the Program on Corporate Compliance and Enforcement (PCCE) or of New York University School of Law. PCCE makes no representations as to the accuracy, completeness and validity of any statements made on this site and will not be liable for any errors, omissions or representations. The copyright of this content belongs to the author and any liability with regards to infringement of intellectual property rights remains with the author.