Infinite Scope: PCAOB Call for Auditors to Replace Lawyers is Massive Overstep
Auditors are charged with determining whether a company’s financial statements present fairly – in all material respects – the financial position, results of operations, and cash flows of the company in conformity with generally acceptable accounting principles. This responsibility has been a central tenet of the vibrancy of our capital markets in the U.S., but a new proposal by the U.S. Public Company Accounting Oversight Board (“PCAOB”) threatens to undermine it – needlessly driving up costs and disproportionately impacting smaller companies.
Currently, auditors consider laws that have a “direct and material effect” on a company’s financial statements. For example, tax laws and IRS regulations have a direct and material effect on a company’s financial statements because they can impact the amount of taxes a company pays. When an auditor is conducting an audit, they have robust and effective procedures in place to make sure that a company is complying with applicable tax laws. This can include reviewing a company’s tax returns, analyzing its tax provisions, and speaking with its tax team.
The PCAOB is proposing to change all that by substantially expanding the auditor’s role. On June 6, 2023, the PCAOB issued a proposal that would require auditors to identify any laws and regulations that could reasonably have a material effect on a company’s financial statements. The scope could be infinite and include hypothetical areas of law that have nothing to do with a company’s financial statements. This would cover every area of law in virtually every country in the world where the company operates—environmental, health and safety, consumer protection, intellectual property, employment, etc. For example, if a company has an employment law issue, auditors may need to look at hiring and firing practices, employment policies and employee performance reviews, and speak with human resources to determine why someone isn’t getting promoted. On top of that, auditors would need to analyze the potential for a company to violate these laws, and if there is even the potential, then they have to communicate it to the audit committee without regard to materiality.
The sweeping breadth of this proposal cannot be understated. It massively expands the scope of an audit and drastically rewrites what is relevant to financial reporting. Auditors lack the expertise to analyze everything, everywhere, all at once, and will need to hire lawyers to fulfill these new duties. Auditors that cannot develop this broad legal expertise – which we expect to be a material amount - will need to merge with other auditors or go out of business, stifling competition and creating further concentration in an industry already dependent on a small number of mega firms.
In addition, the legal costs would be astronomical—doubling or tripling audit fees for listed companies—yet the PCAOB has made no meaningful effort to quantify the cost, impact, or value of the proposal.
For these reasons, on August 11, 2023, Nasdaq submitted a comment letter urging the PCAOB to withdraw the proposal and conduct a robust economic analysis before reissuing any proposed rules.
Our efforts on this PCAOB proposal represent a continuation of our history of unrelenting advocacy on behalf of our listed companies, clients and investors for rules to improve the capital markets and capital formation. Recently, Nasdaq was the only U.S. exchange that submitted a comment letter in support of changes to Delaware law, which simplify a major stockholder voting hurdle that has confronted many companies. We also raised concerns about the SEC’s cybersecurity proposal and were pleased to see some of our concerns considered in the final rule in July.
Nasdaq regularly solicits views from listed companies, investors and other interested market participants regarding issues that are important to them, and we thank those issuers who shared their concerns with us on these important issues. We will continue to share our issuers’ views with regulators and legislators on proposals impacting the public company model. We are committed to supporting reforms that avoid impediments to capital formation and foster investor access to innovative companies like those listed on Nasdaq.
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