Exposing Corruption and Preventing Abuse of Power

GameStop Isn't the Only Urgent Issue Facing the SEC

Commodity Futures Trading Commission Chairman Gary Gensler testifies before the Senate Banking, Housing and Urban Affairs Committee in the Dirksen Senate Office Building on Capitol Hill July 30, 2013 in Washington, DC. (Photo by Chip Somodevilla / Getty Images)

As Gary Gensler appears before the Senate on Tuesday for his confirmation hearing to lead the Securities and Exchange Commission, senators may be tempted to zero in on the hot news topics of the day, like GameStop, Robinhood, and short selling, but they should not ignore the other urgent issues facing the SEC right now.

It’s not that “meme stocks” don’t warrant scrutiny; they certainly do. But the Senate must also use this opportunity to guarantee that the SEC and that its subordinate agencies are working across the board to safeguard investors and the larger economy.

In particular, the Senate should ask Gensler about his plans for oversight of the Public Company Accounting Oversight Board (PCAOB). The little-known board was created in 2002 to monitor the audit industry and protect the public’s investments in the stock market and retirement funds. In the wake of the Enron and WorldCom scandals, in which both companies defrauded investors by misleading them as to companies’ financial health, the government felt this board was urgently needed to prevent future crises.

The PCAOB doesn’t seem to be working as intended and is in desperate need of reform.

But the PCAOB doesn’t seem to be working as intended and is in desperate need of reform. An investigation by the Project On Government Oversight (POGO) found that the accounting board is a “feckless” enforcer that’s become cozy with the very industry it regulates.

Since the PCAOB began operations in 2003, its annual inspection reports on the U.S. offices of the Big Four audit firms cited 808 instances of defective audits in which firms should not have signed off on or verified a client’s financial statements, internal controls, or both. However, POGO found that the board has brought a mere 18 enforcement cases, involving a total of 21 audits, against the Big Four or employees of the firms.

On top of that, the PCAOB has only fined the Big Four companies a total of just $6.5 million. If the board had fined the firms for all 808 of the audits found to be severely botched, the government could have fined the firms more than $1.6 billion total.

If enforcement is meant to deter poor performance and promote good auditing practices, what message is the PCAOB sending to auditors by barely enforcing its own rules and laws?

On top of minimal enforcement, the PCAOB’s enforcement charges, hearings, and related proceedings are hidden from public view while they run their legal course, which often takes years. So although the board’s inspection reports are public, when it does decide to take the further step of considering an enforcement action, investors are left in the dark about those proceedings until a final decision has been made or a settlement has been reached. This is problematic; if an auditor or firm is facing charges by the PCAOB, the public should know if their potential auditors are accused of poor performance.

It’s worth noting that SEC civil or administrative charges, as well as charges and indictments in the criminal justice system, are disclosed, and the ensuing enforcement proceedings unfold in public. And the PCAOB itself has argued that the secrecy of its enforcement proceedings is contrary to the public interest.

A report by POGO found that more than 40% of PCAOB employees had worked for the Big Four audit firms.

Another critically important issue facing the PCAOB is the revolving door between the board and the firms it regulates, which often creates conflicts of interest, or at the very least the appearance of conflicts.

A 2020 report by POGO found that, as of November 2019, more than 40% of PCAOB employees had worked for the Big Four audit firms. At the same time, more than 160 people working for the Big Four had previously worked for the accounting board.

This raises concerns that those jumping from industry to regulator will use their power to advance the agenda of a past or future employer in the private sector, or that those who do the reverse will use the knowledge and relationships they developed working as regulators to help their current employer game the system and gain an unfair advantage.

This latter concern isn’t just a hypothetical issue. In one of the worst cases of the revolving door in recent memory, KPMG partners hired PCAOB employees, pumped them for inside information on the oversight board’s plans, and then exploited the information to cheat on upcoming inspections. Meanwhile, PCAOB employees angled for jobs at KPMG and divulged regulatory secrets to the audit firm. This egregious behavior resulted in KPMG paying a $50 million penalty in 2019.

Senators should press Gensler to commit to creating a “cooling off period” for employees coming and going between service at the PCAOB and one of the Big Four accounting firms. This would greatly improve ethics and independence at the audit agency.

Tuesday’s confirmation hearing is an incredible opportunity for the Senate to conduct needed and long overdue oversight of an agency that has not lived up to its mission or potential. As the nominee to lead the SEC, Gary Gensler will be in a position to set a new tone and agenda for the PCAOB. The Senate should hold his feet to the fire, and ensure PCAOB reform is one of his priorities.