PCAOB staff issues Spotlight on public accounting firm quality control remediation – suggesting closer scrutiny of remediation efforts
On February 2, 2023, Public Company Accounting Oversight Board (PCAOB) inspection staff published a Spotlight on Additional Insights on the Remediation Process identifying “additional insights” or factors that inspection staff consider in assessing whether a firm has appropriately remediated any quality control criticisms that were identified through the PCAOB’s inspection process.
This is the first time PCAOB staff has offered insights into their remediation evaluation process since 2013. It also signals that the PCAOB will view firm’s quality control remediation efforts more stringently going forward.
The PCAOB oversees the audits of public companies and certain registered brokers and dealers. The PCAOB’s oversight mission is accomplished, in part, through its inspection of audits conducted by registered public accounting firms.
Although the PCAOB regularly publishes its reports of inspection, Section 104(g)(2) of the Sarbanes-Oxley Act prohibits the publication of any portion of an inspection report that deals with criticisms of or potential defects in the quality control systems of an accounting firm if those criticisms are “addressed” by the firm to the PCAOB’s satisfaction within 12 months of the date of an inspection report. Accordingly, any quality control criticisms – which appear in “Part II” of an inspection report – are nonpublic when the inspection report is issued and remain so absent a finding by the Board that a firm has failed to timely remediate such criticisms.
The PCAOB has historically considered quality control criticisms to be “addressed” to the Board's satisfaction if, within the 12-month period, a firm “has demonstrated substantial, good faith progress toward achieving the relevant quality control objectives . . .” [PCAOB Release 104-2006-077]. A firm need not “completely and permanently cure any particular quality control” criticism for it to be considered “addressed” by the Board to avoid publication of quality control-related inspection findings.
Pursuant to PCAOB Rule 4009, inspection staff must recommend to the Board that it determine that a firm either has or has not satisfactorily addressed any quality control criticisms within the relevant time period. In 2013, PCAOB inspection staff issued guidance describing the criteria relevant to its recommendations to the Board concerning the sufficiency of a firm’s remediation efforts. [2013 Guidance]. These factors include:
- Change: Does the remedial step represent a change to the firm's system of quality control that was in effect at the time of the conduct that resulted in the quality control criticism
- Relevance: Is the remedial step responsive to and does it specifically address the quality control criticism described in the inspection report?
- Design: Is the remedial step appropriately designed (either individually or in combination with other actions) to remediate the quality control criticism?
- Implementation: To what extent was the remedial step put in operation by the close of the 12-month remediation period and, if not fully implemented, has the firm demonstrated an appropriate level of diligence and reasonable progress in addressing the criticism during the 12-month period?
- Execution and Effectiveness: Has the remedial step achieved (or, if sufficient time has not passed to measure results, is it expected to achieve) the proposed effect that it was designed to achieve?
Historically, the PCAOB has given firms some latitude in addressing quality control criticisms so long as a firm took reasonable steps to implement and execute remedial measures within the 12-month window. Recently, however, the PCAOB board appears to have grown increasingly impatient with public accounting firms’ quality control remediation efforts.
In a speech in December 2022, PCAOB Chair Erica Williams warned that inspection findings were trending in the wrong direction and stressed that “[f]irms must sharpen their focus and prioritize their efforts to increase audit quality.” She noted that firms’ quality control “systems lay the very foundation” of quality audits. Shortly after this speech, the Board concluded two firms had failed to timely remediate quality control criticisms contained in their respective inspection reports and publicly disclosed those criticisms.
The inspection staff Spotlight highlights “additional insights” that have been “gleaned from the PCAOB’s years of evaluating remediation efforts.” Although the Spotlight indicates that these “additional insights” do not alter or replace prior Board or staff guidance, the Spotlight does shed additional light on inspection staff’s assessment of firms’ remediation efforts and may suggest more rigorous scrutiny of these efforts going forward. The Spotlight’s “additional insights” include:
- Repeated or persistent criticisms require a new or enhanced response. The Spotlight notes that for each year that a quality control criticism persists, “the actual implementation, execution, and tangible results of a firm’s remedial steps take on increasing importance in the inspection staff’s evaluation” of a firm’s remediation efforts. A criticism that occurs in at least two consecutive inspection reports, or that occurs consistently, even if it skips one or two inspection reports, is considered a repeat or persistent criticism. Inspections staff will also consider similar deficiencies, regardless of how these deficiencies have been categorized in prior inspection reports, as persistent or repeated quality control deficiencies in assessing the adequacy of a firm’s remedial steps.
- The importance of root cause analysis. The Spotlight reveals that inspection staff increasingly find a firm’s own analysis of the root cause(s) of a given quality control criticism helpful in assessing a firm’s remediation efforts. “[T]he more thoughtful the analysis, the more likely a firm will identify the major causal factors and the greater the likelihood that a firm can design and implement remediation efforts that will be effective in preventing recurrence of similar deficiencies.” The Spotlight also suggests that it is a “good practice” to undertake a root cause analysis and begin to develop and implement remedial steps before the issuance of a final inspection report.
- How the PCAOB considers subsequent inspection results. The Spotlight advises that strong remedial efforts by a firm, coupled with effective firm monitoring procedures and timely adjustments to a firm’s quality control systems, can weigh favorably in inspection staff’s recommended remediation determination, even if subsequent inspection results indicate recurrences of the same type of deficiency. The Spotlight indicates, however, that this may be more of the exception than the rule and notes that certain types of actions, such as training and intra-firm communications, alone may be viewed as insufficiently strong steps to overcome poor subsequent inspection results.
- How the PCAOB evaluates the design of new or revised firm guidance, tools, or policies. For remedial actions such as new or revised guidance or policies, inspection staff will consider a number of factors, apart from the substance of the guidance or policy itself, including (1) the effective date of the guidance or policy; (2) the method of communication and reinforcement to practitioners; and (3) whether a specific group or individual is responsible for execution and/or oversight and monitoring of the new policy/guidance. If a firm’s remedial plans include the introduction of a new audit tool, inspection staff will also consider whether use of the tool is mandatory or left to the discretion of its audit professionals, and whether use of the new guidance or tool is widely adopted across the firm.
- What the PCAOB considers when evaluating the design of training programs. The Spotlight identifies several factors inspection staff may consider in assessing the design of training programs intended to address quality control criticisms, such as (1) whether the training is specifically tailored, and provided to the appropriate levels of professionals within the firm who would be expected to perform or review the audit procedures that resulted in the quality control criticisms; (2) the extent to which the training is mandatory; and (3) the training delivery method (eg, in-person or self-study), among other factors. The staff will also consider a firm’s processes for monitoring participation (and non-participation) in remedial training programs.
- PCAOB expectations on the timing of remediation design and implementation. The Spotlight indicates that inspection staff generally expects a firm to design and implement appropriate remedial actions no later than the end of the 12-month deadline. Although staff recognizes that, in some cases, the implementation of longer-term remediation plans (extending beyond the 12-month deadline) is appropriate, in these circumstances staff’s expectations will become more exacting. Specifically, inspection staff may consider “not only whether the firm has done all it reasonably could within the 12-month period, but also whether the firm has established reasonable milestones reflecting an appropriately aggressive approach to complete implementation.” Moreover, if an action has not been fully implemented prior to the 12-month deadline, such (planned) remedial action will be given no weight by inspection staff unless that remedial action is “one that, by its nature, could not have been completely implemented within the 12-month period,” and the firm provides evidence of a project plan and steps taken prior to the end of the remediation period.
- The value of ongoing dialogue. Finally, the Spotlight encourages firms to initiate a dialogue with the inspection staff as early as possible within the 12-month remediation period. Staff notes that the earlier that a firm initiates a dialogue with the inspection staff, the better the firm will be able to adjust its approach, if necessary, to achieve a favorable inspection staff recommendation. Further, inspection staff expect annually inspected firms to share their preliminary remediation plans in writing with staff within 60 days of issuance of any inspection report containing quality control criticisms. Other firms are encouraged to do so within six months of any such inspection report.
Takeaways – more exacting remediation expectations
The Spotlight notes that the PCAOB is currently reevaluating the criteria used to evaluate firms’ remediation efforts. Although that evaluation is ongoing, the Spotlight suggests that the PCAOB is moving away from an expectation that firms simply make “good faith progress” in their remediation efforts (within the 12-month window) to a more exacting expectation. Indeed, the staff Spotlight reveals that a firm must demonstrate that it “has done all it reasonably could within the 12-month period” to address quality control criticisms.
Further, although the 2013 staff guidance indicates that inspection staff would consider a firm’s “level of diligence” should it fail to fully implement remedial measures within the 12-month window, the Spotlight reveals that staff will now give no weight to any measure not fully implemented within the 12-month window absent a showing that such measure “could not” have otherwise been timely implemented.
These and other “insights” contained in the Spotlight indicate that the PCAOB – consistent with its more aggressive approach to enforcement [see prior alert] – is likely to apply more rigorous scrutiny to firms’ remediation efforts. As a result, registered public accounting firms should be prepared to provide detailed remediation plan and achievable milestones for the implementation of such plans following negative inspection findings. Similarly, firms should be prepared to engage with inspection staff in an ongoing dialogue concerning a firm’s remedial efforts and to demonstrate to staff the concrete steps a firm has taken to address quality control criticism within the 12-month window.
If you have any questions regarding the PCAOB’s Staff Spotlight or the potential impact on your business, please contact any of the authors or your DLA Piper relationship attorney.