What Is the Public Company Accounting Oversight Board?
The Public Company Accounting Oversight Board, known as the PCAOB, is the organization that oversees the auditors of public companies and of SEC-registered broker-dealers. Investor.gov's glossary defines it as a private-sector, nonprofit corporation created by the Sarbanes-Oxley Act of 2002 to oversee accounting professionals who provide independent audit reports for publicly traded companies. The PCAOB's own website states that it oversees the audits of public companies and SEC-registered brokers and dealers in order to protect investors and further the public interest in the preparation of informative, accurate, and independent audit reports.
The PCAOB is a separate body from the SEC and from FINRA. It is not the SEC, and it is not a self-regulatory organization like FINRA. It oversees the audit, which is the independent examination of a company's financial statements, and the accounting firms that perform it. This entry explains why the PCAOB was created, how its board is built, what the statute tells it to do, how the SEC oversees it, how it is funded, and where broker-dealers meet it.
Why the PCAOB Was Created
A PCAOB Board member described the background in a 2013 speech. He said that literally billions in earnings and assets were restated due to accounting errors and irregularities at Enron and WorldCom, and that the Sarbanes-Oxley Act, which created the PCAOB, was passed with overwhelming support from both parties in July 2002. He gave the stated purpose of the legislation as protecting investors by improving the accuracy and reliability of corporate disclosures.
Investors rely on financial statements, and an independent auditor examines those statements and expresses an opinion on them. The statute defines an audit as an examination of the financial statements of an issuer by an independent public accounting firm, in accordance with the rules of the Board or the SEC, for the purpose of expressing an opinion on such statements. The PCAOB exists to oversee the firms that do this work.
What Kind of Organization It Is
The statute that establishes the Board states its purpose in one sentence. The Board is established to oversee the audit of companies that are subject to the securities laws, and related matters, in order to protect the interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports.
The statute also addresses its legal status. It provides that the Board shall not be an agency or establishment of the United States Government and, except as otherwise provided in the Act, shall be subject to, and have all the powers conferred upon a nonprofit corporation by, the District of Columbia Nonprofit Corporation Act. That is why Investor.gov calls it a private-sector, nonprofit corporation. Even so, the Act gives the SEC oversight and enforcement authority over the Board, which a later section of this entry describes.
The Board and Its Members
The statute provides that the Board has five members, appointed from among prominent individuals of integrity and reputation. It provides that two members, and only two members, of the Board shall be or have been certified public accountants. It provides that each Board member serves a term of five years, and until a successor is appointed. And it directs the SEC, after consultation with the Chairman of the Board of Governors of the Federal Reserve System and the Secretary of the Treasury, to appoint the chairperson and the other initial members of the Board.
Who and What the PCAOB Oversees
The statute uses the word issuer for the companies whose audits fall within the Board's oversight. It defines an issuer as one whose securities are registered under section 12 of the Securities Exchange Act of 1934, which the statute cites as section 78l of title 15, or that is required to file reports under section 15(d) of that Act, which the statute cites as section 78o(d), or that files or has filed a registration statement that has not yet become effective under the Securities Act of 1933 and that it has not withdrawn.
The oversight extends to the accounting firms that audit them. The statute defines a registered public accounting firm as a public accounting firm registered with the Board in accordance with the Act. The PCAOB's website states that it inspects registered public accounting firms in connection with audits of U.S. public companies, other issuers, and broker-dealers.
What the PCAOB Does
The PCAOB's website lists its oversight activities as standard-setting, inspections, enforcement, international cooperation, and registration. A PCAOB Board member described the core responsibilities in four parts: register audit firms, write auditing standards, inspect audit firms, and investigate, conduct disciplinary proceedings, and impose sanctions on auditors and audit firms as needed. He summarized it by saying that, essentially, the PCAOB audits the auditors.
Registration
Registration is the entry requirement. The statute provides that it is unlawful for any person that is not a registered public accounting firm to prepare or issue, or to participate in the preparation or issuance of, any audit report with respect to any issuer, broker, or dealer.
The application for registration asks for a substantial amount of information. It includes the names of the issuers, brokers and dealers for which the firm prepared or issued audit reports, the annual fees the firm received from each of them for audit services, other accounting services and non-audit services, a statement of the firm's quality control policies, a list of the accountants who participate in the preparation of audit reports, and information about criminal, civil or administrative actions or disciplinary proceedings pending against the firm.
Standards
The statute directs the Board to establish, by rule, auditing and related attestation standards, quality control standards, ethics standards and independence standards to be used by registered public accounting firms in the preparation and issuance of audit reports. The PCAOB's website states that the Board establishes and amends auditing and related professional practice standards for registered public accounting firms.
Auditor Independence
The statute addresses auditor independence directly in its audit requirements for issuers. It makes it unlawful for a registered public accounting firm to provide certain non-audit services to an audit client contemporaneously with the audit. The list in the statute is specific. It names bookkeeping or other services related to the accounting records or financial statements, financial information systems design and implementation, appraisal or valuation services, fairness opinions and contribution-in-kind reports, actuarial services, internal audit outsourcing services, management functions or human resources, broker or dealer, investment adviser, or investment banking services, and legal services and expert services unrelated to the audit. The list ends with any other service that the Board determines, by regulation, is impermissible.
The list has two features that apply to securities professionals. The first is that it includes broker or dealer, investment adviser and investment banking services. An accounting firm that audits a company may not, at the same time, act as that company's broker-dealer or investment adviser. The second is that the last item gives the PCAOB a role. The Board can determine, by regulation, that another service is impermissible, so the list is not fixed forever by the statute alone.
The statute also deals with services that are not prohibited. It provides that a registered public accounting firm may engage in a non-audit service for an audit client only if the activity is approved in advance by the audit committee. The statute also waives the advance approval requirement for non-audit services that meet conditions set out in the statute, which this entry does not cover, and a reader who needs the exact conditions should read the statute itself.
The audit committee has its own responsibility under the statute. The audit committee of an issuer must be directly responsible for the appointment, compensation and oversight of the work of the registered public accounting firm that the issuer employs.
SEC Rule 17a-5 adds a related requirement for broker-dealers. It provides that the independent public accountant must be qualified and independent in accordance with Rule 2-01 of Regulation S-X, and that the accountant must be registered with the PCAOB if required by the Sarbanes-Oxley Act of 2002.
What the Auditor's Report Says
The audit report is the document in which the auditor states its opinion. The PCAOB's auditor reporting page states that the new auditing standard retained the pass/fail opinion of the existing auditor's report, but made significant changes to the auditor's report.
One of the additions is the critical audit matter, often called a CAM. The PCAOB defines a critical audit matter as any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that relates to accounts or disclosures that are material to the financial statements and involved especially challenging, subjective, or complex auditor judgment. The requirement took effect in stages. The PCAOB states that the provisions on critical audit matters took effect for audits of fiscal years ending on or after June 30, 2019, for large accelerated filers, and for fiscal years ending on or after December 15, 2020, for all other companies to which the requirements apply.
The PCAOB's implementation material states that critical audit matters are not required for audits of brokers and dealers, registered investment companies other than business development companies, employee stock purchase, savings and similar plans, and emerging growth companies. An auditor's report on a broker-dealer therefore differs from an auditor's report on a public company in this respect. The PCAOB's auditor reporting page includes an annotated example auditor's report for the audit of a broker or dealer as a separate resource.
Inspections
The PCAOB inspects registered firms. Its website states that it inspects registered public accounting firms to assess compliance with the Sarbanes-Oxley Act, the rules of the Board, the rules of the SEC, and professional standards.
The statute sets the frequency. For a firm that regularly provides audit reports for more than one hundred issuers, the Board must conduct an inspection annually. For a firm that regularly provides audit reports for one hundred or fewer issuers, the Board must conduct an inspection not less frequently than once every three years. The statute addresses inspections of audit reports for brokers and dealers in a separate paragraph. In an inspection the Board must identify any act, practice or omission to act by the registered firm that may be in violation of the Act, report it where appropriate to the SEC and each appropriate State regulatory authority, and begin a formal investigation or take disciplinary action where appropriate.
Inspection Reports
An inspection ends in a report. The PCAOB's guide to reading its inspection reports states that its inspections are designed to review portions of a firm's issuer audits and evaluate elements of a firm's system of quality control. The guide also says the inspections include risk-based selections and random selections of issuer audits.
The guide describes a report with several parts. There are introductory materials, an inspection overview, Part I, which is divided into Part I.A and Part I.B, Part II on quality control, and an appendix containing the firm's response. The two divisions of Part I are different. Part I.A covers deficiencies where the firm, at the time it issued its audit report, had not obtained sufficient appropriate audit evidence. Part I.B covers non-compliance with PCAOB standards or rules that does not directly relate to whether the firm obtained sufficient appropriate audit evidence.
The guide also explains what the public sees. It states that when inspection reports are first issued, the public will not see Part II of the report. If a firm does not address the quality control deficiencies within twelve months, the guide states that Part II of the report will be reissued publicly. The guide refers to the 2018 inspection reports as the first to use this format.
Investigations and Discipline
The statute directs the Board to establish, by rule, fair procedures for the investigation and disciplining of registered public accounting firms and associated persons of such firms. In a proceeding to decide whether a firm or an associated person should be disciplined, the Board must bring specific charges, notify the firm or person and give an opportunity to defend against the charges, and keep a record of the proceedings.
The range of sanctions the statute lists is wide. It includes temporary suspension or permanent revocation of registration, a temporary or permanent suspension or bar of a person from further association with a registered firm, a temporary or permanent limitation on activities, functions or operations, a civil money penalty for each violation, censure, required additional professional education or training, and any other appropriate sanction provided for in the Board's rules. This entry does not give penalty amounts, because a reader who needs them should use the current statute and rules.
SEC Oversight of the PCAOB
The PCAOB is not independent of the SEC. The statute provides that the SEC shall have oversight and enforcement authority over the Board, as provided in the Act. It provides that no rule of the Board shall become effective without prior approval of the SEC.
The SEC also has a role when the Board sanctions a firm. The statute provides that the SEC may enhance, modify, cancel, reduce, or require the remission of a sanction imposed by the Board if it finds that the sanction is not necessary or appropriate in furtherance of the Act or the securities laws, or is excessive, oppressive, inadequate, or otherwise not appropriate to the finding or the basis on which the sanction was imposed.
How the PCAOB Is Funded
The statute provides that the Board's budget, reduced by any registration or annual fees received, is payable from annual accounting support fees. The fee is allocated among issuers, and the statute also provides that each broker or dealer shall pay to the Board the annual accounting support fee allocated to it. The Board establishes the fee, or a formula for computing it, with the approval of the SEC, and the Board's budget is subject to the SEC's approval.
Broker-Dealers and the PCAOB
The PCAOB's role in the broker-dealer industry came later than its role with public companies. The PCAOB's website states that the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, known as the Dodd-Frank Act, gave the PCAOB oversight of auditors of broker-dealers registered with the SEC. It states that the PCAOB has registration, inspection, standard-setting and disciplinary authority over the auditors of broker-dealers, and that the Act authorized the PCAOB to establish, by rule, an inspection program for them.
The website's page for broker-dealer auditors refers to two attestation standards by name: Examination Engagements Regarding Compliance Reports of Broker-Dealers, known as AT No. 1, and Review Engagements Regarding Exemption Reports of Broker-Dealers, known as AT No. 2.
The connection to the broker-dealer itself comes through SEC Rule 17a-5. The rule states which brokers and dealers it applies to and contains carve-outs, so this entry describes its general requirements. The rule provides that the independent public accountant must be registered with the PCAOB if required by the Sarbanes-Oxley Act of 2002. The Act's registration provision, described earlier, makes it unlawful for a firm that is not registered to prepare or issue an audit report with respect to any broker or dealer. The rule also provides that the accountant's reports are prepared in accordance with the standards of the PCAOB, and that the annual reports must be filed not more than sixty calendar days after the end of the broker-dealer's fiscal year. A broker-dealer is therefore not regulated by the PCAOB, but its independent public accountant must be registered with the PCAOB where the Act requires it.
The Compliance Report and the Exemption Report
SEC Rule 17a-5 asks a broker-dealer to file more than audited financial statements. It also calls for either a compliance report or an exemption report, depending on the firm's status under SEC Rule 15c3-3, the customer protection rule. The rule provides that if a broker-dealer did not claim to be exempt from Rule 15c3-3 throughout the most recent fiscal year, or if it is subject to a specified paragraph of that rule, it files a compliance report. If it did claim to be exempt throughout the most recent fiscal year and is not subject to that paragraph, it files an exemption report.
The independent public accountant has a different job for each. For the compliance report, the rule provides that the accountant prepares a report based on an examination of the statements the rule requires. For the exemption report, the rule provides that the accountant prepares a report based on a review of the statements the rule requires. The PCAOB's two attestation standards for broker-dealers line up with this division, because the first is titled Examination Engagements Regarding Compliance Reports of Broker-Dealers and the second is titled Review Engagements Regarding Exemption Reports of Broker-Dealers.
The rule also says where the annual reports go. They must be filed with the designated examining authority for the broker-dealer, and with the Securities Investor Protection Corporation if the broker-dealer is a SIPC member.
An Illustration
An illustration shows how the pieces fit. Suppose a broker-dealer needs its annual report audited. Under the Act's registration provision, a firm that is not registered with the PCAOB may not prepare or issue an audit report with respect to a broker or dealer, and under SEC Rule 17a-5 the accountant's reports must follow PCAOB standards. If the firm hired an accounting firm that was not registered, the registration requirement would not be met. The PCAOB would not be examining the broker-dealer. It would be overseeing the auditing firm, through registration, standards, inspections and discipline. This illustration is simplified and does not describe any actual broker-dealer or accounting firm.
The PCAOB Compared With the SEC and FINRA
Three organizations are involved, and each has a different subject. The SEC regulates the securities markets and broker-dealers, approves the PCAOB's rules and has oversight and enforcement authority over it. FINRA is a self-regulatory organization for broker-dealers and their registered persons. The PCAOB oversees the accounting firms that audit issuers and broker-dealers. The PCAOB's own materials describe its authority over broker-dealers as authority over their auditors.
Common Misunderstandings
One misunderstanding is that the PCAOB is part of the SEC. The statute provides that the Board is not an agency or establishment of the United States Government, although the SEC has oversight and enforcement authority over it.
A second misunderstanding is that the PCAOB regulates public companies. It oversees the audits of public companies and the accounting firms that perform them.
A third misunderstanding is that the PCAOB regulates broker-dealers. Its authority over the broker-dealer industry is authority over auditors of broker-dealers.
A fourth misunderstanding is that any accountant can audit a broker-dealer. The Sarbanes-Oxley Act makes it unlawful for a firm that is not registered with the PCAOB to prepare or issue an audit report with respect to any broker or dealer, and SEC Rule 17a-5 provides that the independent public accountant must be registered with the PCAOB if required by the Act.
A fifth misunderstanding is that the PCAOB writes its rules without review. The statute provides that no rule of the Board becomes effective without prior approval of the SEC.
A sixth misunderstanding is that the PCAOB is funded through government appropriations. The statute provides that the Board's budget is payable from annual accounting support fees, which are paid by issuers and by broker-dealers.
A seventh misunderstanding is that the Board consists only of accountants. The statute provides that only two of its five members may be or have been certified public accountants.
An eighth misunderstanding is that an accounting firm can audit a company and also act as its broker-dealer or investment adviser. The statute lists broker or dealer, investment adviser and investment banking services among the services that a registered public accounting firm may not provide to an audit client contemporaneously with the audit.
A ninth misunderstanding is that a broker-dealer's audit report looks like a public company's. The PCAOB states that critical audit matters are not required for audits of brokers and dealers.
A tenth misunderstanding is that every PCAOB inspection report is fully public as soon as it is issued. The PCAOB's guide states that the public will not see Part II of the report when it is first issued, although it will be reissued publicly if quality control deficiencies are not addressed within twelve months.
Key Points
The PCAOB is a private-sector, nonprofit corporation created by the Sarbanes-Oxley Act of 2002 to oversee the audits of public companies and SEC-registered broker-dealers, in order to protect investors and further the public interest in informative, accurate and independent audit reports.
It registers accounting firms, establishes auditing and related standards, inspects registered firms, and investigates and disciplines firms and associated persons.
The Board has five members, two and only two of whom may be or have been certified public accountants, and each member serves a five-year term and until a successor is appointed.
The SEC has oversight and enforcement authority over the PCAOB, approves its rules and its budget, and may review the sanctions it imposes.
The Dodd-Frank Act of 2010 gave the PCAOB oversight of the auditors of SEC-registered broker-dealers, and SEC Rule 17a-5 provides that a broker-dealer's independent public accountant must be registered with the PCAOB if required by the Sarbanes-Oxley Act.
The statute bars a registered public accounting firm from providing listed non-audit services, including broker or dealer, investment adviser and investment banking services, to an audit client contemporaneously with the audit, and it requires the audit committee to approve other non-audit services in advance.
A broker-dealer files either a compliance report or an exemption report with its annual reports. The accountant examines the first and reviews the second, and the PCAOB has a separate attestation standard for each.
