The first release entitled, The Process for Board Determinations Regarding Firms’ Efforts to Address Quality Control Criticisms in Inspection Reports (March 21, 2006), provides information on the Board’s process for determining whether the accounting firm has favorably or unfavorably addressed the quality control criticisms cited in the nonpublic portion of the inspection report within the 12 month period. Part I of this release includes the procedural aspects of this process and Part II describes the Board’s approach to making the substantive determinations regarding the quality control criticisms. The Board provides the opportunity for dialogue so that a firm acting in good faith can receive timely feedback from the staff in an effort to meet the 12 month deadline to satisfactorily address the quality control criticisms.
- PCAOB Rule 4009 Submission: By the end of the 12 month deadline, a firm who wishes to keep the quality control criticisms nonpublic may make a submission to the Board, pursuant to PCAOB Rule 4009, outlining the ways in which the firm has addressed the criticisms (Rule 4009 Submission). Neither dialogue with the inspection staff nor a Rule 4009 submission are requirements, however, failure to do so constitutes a failure to address the criticisms to the Board’s satisfaction and will result in these criticisms becoming public.
- PCAOB Processing of Rule 4009 Submissions: Upon receipt of a timely Rule 4009 Submission, the Board will make their determination of whether the criticisms have been addressed to their satisfaction; however, there is no deadline by which this determination will be made. Along with each Rule 4009 Submission, the Board will also receive a recommendation from the Director of the Division of Registration and Inspections which, among other things, takes into account any dialogue between the firm and the inspection staff within the 12 month period. It is also possible in some cases that the Board will delay a determination pending follow-up inspection procedures to confirm aspects of the Rule 4009 Submission.
Unfavorable Determination – After consideration of the Rule 4009 Submission,the Board determines that the firm failed to address the quality control criticisms to its satisfaction.
- Board will notify the firm (If the firm failed to make a Rule 4009 Submission, the quality control criticisms will be made public without any separate notice to the firm by the Board).
- The firm has 30 days to contest the unfavorable determination by seeking review by the Securities and Exchange Commission (SEC or the Commission) before the determination becomes final and is made public. If the firm seeks this review, the Board delays public disclosure for an additional 30 days, or a longer period depending on if the Commission orders a longer period to complete their review.
- If the firm seeks the SEC review and the SEC agrees with the Board’s determination, the unfavorable determination is final and the Board will make public the relevant, previously nonpublic, portions of the original report.
- If the firm does not seek the SEC review, the unfavorable determination is final and the Board will make public the relevant, previously nonpublic, portions of the original report.
- Notice of this unfavorable determination will be indicated on the Inspection Reports page of the Board’s Web site with a notation next to the firm’s name and the previously nonpublic portions will now be publicly available if you click on the link for the respective firm.
Favorable Determination – Reflects the Board’s assessment that the firm has demonstrated substantial, good faith progress toward achieving the relevant quality control objectives, sufficient to merit the result that criticisms remain nonpublic. However, a favorable determination does not necessarily indicate that the firm completely and permanently cured any particular quality control defect; it does indicate that the firm has identified steps and is making good progress in implementing those steps.
- Board will transmit notice of this favorable determination to the firm and will provide the SEC and the appropriate state regulators with a copy of this notice.
- No portion of the report describing the quality control criticism will be made public if there is a favorable determination.
- The Board does not provide public notice of a favorable determination which is consistent with the fact that when the Board first issues an inspection report, the Board does not state in the nonpublic portion of the report whether there even was a quality control deficiency.
Differences Between the Rule 4009 Process and the Board’s Disciplinary Process
The Rule 4009 process is part of the Board’s inspection program, whereby the Board takes a supervisory approach to oversight and seeks through constructive dialogue to encourage firms to improve their practices and procedures. The Board believes that both the effectiveness and the efficiency of the Board’s programs are enhanced when firms opt for constructive engagement rather than an adversarial approach. Therefore, the Board seeks and encourages constructive engagement, in its inspection program, rather than putting firms in a position where they will perceive their self-interest is better served by an adversarial and confrontational posture.
However, when a firm fails to address appropriately an inspection report’s quality control criticism, the confidential portion of the original report will be made public. If the firm’s inadequate response and perceived quality control deficiency warrant additional action, the Board may initiate disciplinary action against the firm for failing to comply with the PCAOB standards.
Differences Between Larger and Smaller Firms
Inspections of smaller firms may reveal quality control criticisms more from inferences drawn from deficiencies in the performance of audits and less often from a review of formal policies and procedures. As a result, an inspection report’s articulation of such criticisms is often in standard, fairly general terms, with the goal of focusing the firm on improving those aspects of its work on audits.
The quality control policies and procedures at larger firms are typically far more complex, extensive, and formal than those at smaller firms. Board inspection procedures are correspondingly more extensive and inspection report discussions of those quality control systems are usually set out in extensive and specific terms. As a result, such criticism tend to focus not only on audit performance issues but also on how the firm designs and implements other aspects of its business that bear on the quality of its audits.
The second release entitled, Observations on the Initial Implementation of the Process for Addressing Quality Control Criticisms Within 12 Months After an Inspection Report (March 21, 2006), includes a general summary of the Board’s observations with respect to the efforts taken by the four largest U.S. accounting firms to address the quality control deficiencies that were identified by the Board within the 2003 Limited Inspections Reports of these firms issued on August 26, 2004.Each of the four largest U.S. public accounting firms submitted timely Rule 4009 Submissions and engaged in substantial dialogue with the Board during the 12 month period regarding efforts taken to address the quality control criticisms in the limited inspection reports. The Board’s assessment resulted in favorable determinations for each of these firms and therefore no portions of these limited inspection reports related to quality control criticisms were made public. Within this release, the Board identifies steps that emerged from the Rule 4009 process to address quality control criticisms in the following areas:
- Audit Performance Internal Inspections Evaluation and Compensation of Partners Independence Establishment and Communication of Policies, Procedures, and Methodologies Acceptance and Continuance of Clients
- Supervision of Foreign Affiliates
For a general discussion of the PCAOB inspection process, view the Statement Concerning the Issuance of Inspection Reports.