Business Leaders Split Over Tying Auditors to Client Misdeeds

The Public Company Accounting Oversight Board is moving forward with plans to require auditors to dig deeper into corporate crimes and regulatory violations and hold them more responsible for their clients’ noncompliance with laws and regulations, called NOCLAR, via proposed rule changes.

The board has pledged to hold a roundtable in 2024 for stakeholders to discuss the sweeping proposal issued last year. Two business leaders offer their perspectives on the plan.

A Much-Needed Update

Jeff Mahoney, CII

The NOCLAR proposal is long overdue. To understand why, it’s important to understand the history of auditors and NOCLAR.

In 2003, the newly formed PCAOB adopted temporary auditing standards written by the American Institute of Certified Public Accountants, including a 1988 standard that obligated auditors to identify, evaluate, and report illegal acts by their clients, including NOCLAR.

The AICPA standards were promulgated by the profession for the profession—an inherent conflict. For practical purposes, Congress permitted the PCAOB to carry over the existing AICPA standards on an interim basis. The expectation was that the PCAOB would produce a more appropriate set of standards going forward.

The NOCLAR proposal, issued more than 20 years later, is but one step toward fulfilling that expectation by replacing the AICPA-written standard.

Congress confirmed the importance of that standard in 1995, when it expanded and codified aspects of the standard in Section 10A of the Securities Exchange Act of 1934.

Some critics of the NOCLAR proposal appear to have ignored this history and suggest the PCAOB is creating a new obligation for auditors that replaces or duplicates management responsibilities. The truth is that the PCAOB is simply attempting to pursue its mission under the Sarbanes-Oxley Act.

This mission is consistent with the Congressional intent of that law and Section 10A of the Securities Exchange Act of 1934 because it attempts to strengthen an obligation of auditors that the profession created.

Even more disappointing, some critics appear to have adopted the Washington, D.C., lobbying strategy of submitting comment letters to the PCAOB that lack useful and substantiated information. In contrast, responsible commentators, including members of the PCAOB’s Investor Advisory Group, carefully reviewed the NOCLAR proposal and offered specific suggestions for how and why certain provisions might be improved.

Commentators differ on which provisions of the NOCLAR proposal should be revised and what those revisions should entail. I remain confident that the PCAOB staff and board will carefully consider all the responsible comments and other input received, including from the pending roundtable, and make needed improvements to provisions of the NOCLAR proposal before adopting a final standard.

Wrong for Capital Markets

Tom Quaadman, US Chamber

For decades, it’s been a well-settled policy that an auditor, when reviewing a business’s financial materials, only needs to identify material instances of a company’s non-compliance with laws or regulations. Serious issues that impact investors need to be disclosed, But other issues, such as parking, speeding tickets, or ministerial acts need not be disclosed because they aren’t relevant to investors.

This approach to auditing has worked—as auditors aren’t police officers—and has created balance while maintaining a responsibility to monitor serious NOCLAR issues that require action to be taken.

However, the PCAOB shocked auditors and businesses last year with a draconian proposal to update the auditing standard on NOCLAR that would completely change public company audits.

The proposal would transform audits into an inquisition. Instead of evaluating the integrity of financial statements, under the proposal, auditors would now have to investigate if companies are out of compliance with applicable laws and regulations across all local, state, federal, and international jurisdictions.

Auditors aren’t lawyers or experts on laws and regulations such as occupational health and safety, environmental protection, intellectual property, and data privacy, among others. Auditors and their clients would need to hire an army of legal and subject matter experts to complete an audit.

Such a radical transformation of the auditor’s role and responsibilities raises questions regarding the PCAOB. For example, the board has failed to identify a problem it needs to solve with such a far-reaching proposal. The NOCLAR proposal would distract auditors, degrade audit quality, and weaken investor protection—all without any clear benefit to investors.

The PCAOB’s economic analysis for the proposed update fails to provide any significant quantitative data, also raising a concern about the policymaking process. NOCLAR’s costs are substantial: the US Chamber of Commerce estimates annual auditing costs for public companies could triple to $54.6 billion—an increase of $36.4 billion—dwarfing the previously inconceivable costs of implementing Section 404 of the Sarbanes-Oxley Act.

Nonetheless, the PCAOB appears committed to finalizing a NOCLAR standard in 2024. But before it does, PCAOB Chair Erica Williams has pledged to hold a roundtable. To avoid that being an empty gesture, the PCAOB must ensure the roundtable has the right people at the table to fairly represent the deeply rooted concerns with its NOCLAR proposal.

The PCAOB’s current proposal is wrong for our capital markets. If the PCAOB wants to update the standard, it should withdraw the current proposal and work to determine if there is a problem that should be addressed.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jeff Mahoney is general counsel for the Council of Institutional Investors.

Tom Quaadman is executive vice president at the US Chamber of Commerce Center for Capital Markets Competitiveness.

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