The PCAOB this week issued an order instituting disciplinary proceedings, making findings, and imposing sanctions against Brock, Schechter & Polakoff, LLP (BSP), and audit partner James Waggoner. BSP and Waggoner were found to have violated PCAOB rules and auditing standards on the audits of three China-based and Taiwan-based companies. Local Chinese CPA firms had approached BSP to sign off on audits of their clients. The local Chinese firm did substantially all of the audit work. PCAOB audit standards do not allow a firm to sign off on audits that are done by another firm.
The use of local Chinese accounting firms to do substantially all the audit work on U.S. listed Chinese companies where a U.S. CPA signed the report was discussed in Staff Audit Practice Alert No. 6 issued on July 12, 2010. The alert disclosed that during the 27-month period ending March 31, 2010 at least 40 U.S. based CPA firms with fewer than five partners and 10 staff had audited U.S. listed Chinese companies. The alert reported that the Board’s inspection staff had identified situations where U.S. based auditors had signed off on audits without even visiting China during the audit.
The dates disclosed in the disciplinary order against BSP and Waggoner suggest that BSP was probably one of the firms identified by the inspection staff during 2010. What is notable is it took another two years before the disciplinary action became public, and that only happened because the firm offered to settle the action. Had the firm chosen to continue to dispute the findings, public disclosure might have been delayed for several more years.
This exposes a serious problem with PCAOB disciplinary actions. Under Sarbanes-Oxley, PCAOB disciplinary proceedings are non-public. Contrast this to disciplinary proceedings with the SEC. When disciplinary proceedings were launched against Deloitte China recently they were immediately announced. We have no idea how many disciplinary actions are currently underway against accounting firms that audit U.S. listed Chinese companies. We do know it will take years to find out - even when the case is settled.
Investors deserve to know when accounting firms face disciplinary action. Because these proceedings take considerable time, firms may continue to issue audit reports even though significant deficiencies have been noted in their work. This creates an incentive for firms to litigate cases against them, even when they know they will ultimately be sanctioned. While there is a process to open cases to public view, it requires the consent of the CPA firm and none have ever consented to doing so.
Bipartisan legislation (HR 3503) proposes to open PCAOB disciplinary actions to public view. At a congressional hearing in Washington in March, PCAOB Chairman James Doty observed that: “This state of affairs is not good for investors, for the auditing profession, or for the public at large”. He is right, and HR 3503 should be enacted.