A colossal conflict of interest compromises the auditing of public companies and the financial security of everyone who depends on them. The Project On Government Oversight is planning a conference on what to do about it. The following is meant to serve as a starting point for discussion. It provides background on the issue and options for potential reform.
Corporations, big accounting firms, and the federal government have been selling the public a lie.
They claim that the financial statements of public companies — including those traded on the stock market — are audited by independent accounting firms.
But the audit firms are not independent.
They are dependent.
The audit firms are chosen and paid by the companies they audit. Just as the company hires its auditor, the company has the power to fire its auditor.
As professor Don Moore of California’s Haas School of Business has put it, “The very notion that the current system allows for truly independent audits is laughably implausible.”1
The system incentivizes auditors to please their clients instead of protecting the public.
In this report, the Project On Government Oversight (POGO) explores ways to realign the incentives and make the system more rational.2 We examine a range of alternatives, from having the government perform audits to eliminating the audit requirement altogether.
The potential reforms include having a third party — such as a regulatory agency, stock exchange, or insurance company — assign auditors.
Sign up for our weekly newsletter!
Get a roundup of POGO's latest work and announcements. Delivered Saturday mornings.
Some ideas, like imposing term limits on auditors, have been debated extensively. Others, like enlisting a “Red Team” to search for problems and paying it a bounty if it finds them, may be new.
We review how the accounting industry has long opposed term limits, historically the leading proposal, and we explain why the present is no time for complacency.
We also explain how arcane rules meant to determine whether audit firms qualify as independent miss the forest for the trees — or maybe for the leaves.
We show how auditing’s perverse incentives have shaped a history of unethical and illegal behavior, how trust in auditors has been misplaced, and why an effective system of checks and balances should harness the power of auditors’ self-interest instead of relying on their consciences.
Part 1 of our report lays out the problem. Part 2 analyzes potential solutions.
We believe the best time to fix the system is now, before it contributes to the next crisis. However, we also take a long view. We recognize that it can take scandals or disasters to stir policymakers to action. The last major U.S. audit reforms were enacted in 2002, after the energy-trading company Enron collapsed in an accounting fraud of historic proportions.
That legislation created a special regulator for auditors of public companies — the Public Company Accounting Oversight Board (PCAOB) — but it left auditing’s fundamental problem intact.
It failed to protect us from subsequent disasters like the crisis of 2008, which brought the global financial system to the brink of collapse.
If policymakers don’t address the auditing problem before the next crisis, we believe they should at least be equipped to act when the next crisis strikes.
And, if the road to audit reform is otherwise blocked, there’s one simple step the government could take.
Abandon the illusion or self-delusion and stop calling dependent auditors independent.
Every public company’s annual financial report perpetuates a lie.
Financial disclosures are supposed to give the public a true picture of a company’s health and profitability. To make them more trustworthy, the government requires that the numbers be audited by independent accountants. The annual financial report includes what it describes as a report by an independent accounting firm, and, in that document, the accounting firm responsible for the audit describes itself as “independent.”
But the audit firm is not independent.
It is dependent.
The audit firm is chosen and paid by the company it is auditing. Just as the company hires its auditor, the company has the power to fire its auditor.
Big companies can pay their audit firms tens of millions of dollars a year, and, for an audit firm, losing a client means cutting off a revenue stream that could otherwise stretch into an open-ended future.3
The auditor’s assessment is formally titled, “Report of Independent Registered Public Accounting Firm.” But only in the Orwellian sense is that accurate, like “War is Peace” and “Freedom is Slavery.” It’s a delusion, an exercise in doublethink.
We’d say this is an open secret, but it’s no secret at all. It’s blindingly obvious.
Auditors are caught in a fundamental conflict of interest.
They are supposed to serve the public. They’re expected to act as watchdogs. “By certifying the public reports that collectively depict a corporation’s financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client,” the U.S. Supreme Court has stated. “This ‘public watchdog’ function demands that the accountant maintain total independence from the client at all times, and requires complete fidelity to the public trust,” the court has said.4
But the corporations are the auditors’ clients, and auditors have powerful motivation to keep their clients happy.
It’s an absurd system. The incentives are fundamentally misaligned.
In a 2020 article in The CPA Journal titled “The Myth of Auditor Independence,” J. Edward Ketz described it as “a patronage system that rewards cozy relationships between auditors and clients and discourages strict adherence” to accounting rules.5
“This patronage system needs to go away — the sooner, the better,” Ketz wrote.6
Similarly, Max H. Bazerman, a professor at Harvard Business School, cut to the heart of the matter in a statement to regulators a decade ago. “If we do want independent audits, it is time to recognize that, without a massive overhaul of the existing system, this goal will ... elude us,” Bazerman wrote. “Society is currently paying enormous costs without getting the very service that the industry claims to provide: independent audits.”7
Don Moore of the Haas School of Business at the University of California at Berkeley put it more succinctly: “The very notion that the current system allows for truly independent audits is laughably implausible.”8
All three of those scholars have noted a body of research showing that, even at a subconscious level, people’s self-interest tends to bias them.
“Due to the often-subjective nature of accounting and the close relationships that exist between accounting firms and their clients, even the most honest auditors can be unintentionally biased in ways that mask a client company’s true financial status, thereby misleading investors, regulators, and even the company’s management,” Bazerman wrote.9
Even the big accounting firm KPMG has acknowledged that, in interactions with corporate managers, auditors can face conflicting pressures.
“Applying professional skepticism is about making tough choices,” the then-chief executive officer of KPMG said in 2012. “At that critical point when the auditor is faced with a decision about whether to keep pushing, either pushing back on management’s representation or pushing forward for more audit evidence, what forces are motivating the auditor to keep at it? And what forces are there that may be pushing in the opposite direction? And the question we’re faced with today is how do we increase those forces that contribute to that skeptical mindset?”10
In some cases, the lie that the auditor is independent is a prelude to others. In some cases, though blessed by the auditor, the financial statements turn out to be erroneous or even fraudulent, and the company’s internal controls — another focus of the audit — turn out to be defective. In the worst cases, lots of people lose. Companies implode, employees lose jobs and benefits, individual investors and pension funds lose money saved for retirement, communities suffer, and chain reactions affect the economy and financial system.11
A recent government proposal would raise the stakes by expanding the scope of audits. It would require companies to make new audited disclosures about how they are affected by severe weather and climate-related risks such as flooding, drought, wildfires, and rising sea levels.12
The climate proposal by the Securities and Exchange Commission could deliver a windfall for audit firms — and a new expense for corporate shareholders.
If society is looking for reliable climate disclosures, it has a vested interest in making sure any audits of those disclosures are reliable.
In this report, the Project On Government Oversight (POGO) explores ways to realign auditing’s incentives and make the audit system more rational. We examine a range of alternatives, from having the government perform audits to eliminating the audit requirement altogether.
We asked five major audit firms and a trade group for the accounting industry what can be done to eliminate auditing’s fundamental conflict of interest. We also invited them to explain in what sense, if any, companies’ outside auditors are independent, and whether it’s dishonest to call them independent. None responded to our questions.13
We believe the best time to fix the system is before it contributes to the next crisis.
However, we also take a long view. We recognize that it can take scandals or disasters to stir policymakers to action. Audits were originally mandated in reaction to the stock market crash of 1929. The last major U.S. audit reforms were enacted in 2002, after the energy-trading company Enron collapsed in an accounting fraud of historic proportions.14 Even after Enron’s meltdown, it was unclear that Congress would do anything. It took another accounting scandal, the implosion of telecommunications giant WorldCom, to drive legislation through Congress and across then-President George W. Bush’s desk.15
That legislation created a new regulator for auditors of public companies — the Public Company Accounting Oversight Board (PCAOB) — but it left auditing’s fundamental problem intact.
If today’s policymakers don’t address the problem in the absence of a crisis, we believe they should be equipped to act when the next crisis strikes.
We also recognize that, when the moment comes, time will be of the essence. Political momentum can fade quickly. A common strategy for industries facing calls for reform is to drag out the deliberative process until any sense of urgency recedes.
We hope this analysis will serve as a basis for discussion. We hope the discussion can help generate a blueprint for reform that policymakers could implement when the political stars align, if not sooner.
The framers of the U.S. system of government believed incentives matter.
They didn’t trust in the goodness of people. “If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary,” James Madison famously wrote in The Federalist Papers.16
The framers of the Constitution sought to harness incentives toward the desired end. They created a system of checks and balances in which ambition was meant to counteract ambition — one where the interests of each branch of government would drive it to restrain the others.17
The roots of many financial crises can be traced in part to misaligned incentives.
For example, the savings and loan crisis of the 1980s and 1990s, in which much of the lending industry received a taxpayer bailout, resulted in part from savings and loan associations making reckless investments with federally insured deposits. In the absence of effective regulation, the federal backstop enabled the gambling.18
Early in the internet age, before a bubble in dot-com stocks burst, Wall Street investment banks fueled the runup with cheerleading “research” reports on companies.19
“The equities analysts of Merrill Lynch and other Wall Street firms were charged with objectively advising retail investors whether to buy or sell publicly traded stock. The analysts had rated some stock a strong buy, while at the same time disparaging it in Internet emails as ‘a piece of junk’ or a ‘powder keg,’” a Harvard Business School case study recounts.20
As a summary of the case study notes, the analysts issuing the “buy” ratings had a conflict of interest: the Wall Street firms they worked for were competing for the dot-coms’ business. The investment banks made money by advising the companies and underwriting the companies’ stock offerings.
Without admitting or denying wrongdoing, 10 major Wall Street firms settled enforcement actions by agreeing to pay a total of almost $1.4 billion and implement reforms.21
The financial crisis of 2008, largely the result of a bubble in subprime mortgages, had many authors. Mortgage brokers and lenders made money up front, incentivizing them to issue loans that borrowers couldn’t afford. Instead of holding onto the loans and relying on borrowers to make a steady stream of monthly payments, lenders offloaded the loans to others. The right to receive the payments was packaged into securities and sold to investors. Bond rating agencies greased the sales by assigning top grades to securities that turned out to be garbage. The bond rating agencies were hired and paid by the businesses issuing the bonds.22 Home appraisers made mortgages possible by vouching that the real estate provided adequate collateral. But appraisers owed their income to lenders, and lenders pressured them to inflate values.23
Like auditors, appraisers lacked independence.
“The integrity of our mortgage system depends on independent appraisals. Again and again our industry-wide investigation found that banks were putting pressure on appraisers to drive up the value of loans just to make a quick buck,” Andrew Cuomo said in 2008, as attorney general of the state of New York.24
No wonder so many mortgages and mortgage-backed securities proved unsustainable. Incentives tend to predict outcomes.
Through those chapters in history and more, auditors failed to protect the public. In many instances, their reports gave no hint that numbers were unreliable, that internal controls were wanting, or that companies they audited were in danger of collapse.
A Washington Post story from 2001 by the author of this report illustrated the problem:
Years before Enron Corp. collapsed, wiping out thousands of jobs and billions of dollars of shareholder wealth, outside auditors from the big accounting firm Arthur Andersen found $51 million of problems in the company’s books — and decided to let them go uncorrected.
While auditing Enron’s 1997 financial results, Andersen proposed that the energy company make “adjustments” that would have cut its annual income by almost 50 percent, to $54 million from $105 million, according to testimony Andersen has presented to Congress.
Enron chose not to make those adjustments and Andersen put its stamp of approval on the company’s financial report anyway.25
Robert Prentice, a professor at the McCombs School of Business at the University of Texas at Austin, has explained why the now-defunct accounting firm might have been predisposed to go along with Enron’s accounting:
Or think of Arthur Andersen’s David Duncan, the auditor in charge of the Enron account. Enron was one of Andersen’s largest clients and Duncan’s career essentially hung on the success of Enron. Andersen was making a healthy $25 million a year auditing Enron and another $27 million by providing nonaudit services. Andersen expected that its Enron related revenue would soon double to $100 million a year. In other words, Andersen, Duncan, and Duncan’s subordinates all had a strong self-interest in concluding that Enron was in good financial shape and that its various financial machinations were consistent with good accounting practices. In the shadow of such a strong self-interest, it would have been very difficult for even an auditor with the best of intentions to make judgments in an objective manner.26
While Arthur Andersen defended its work, the firm acknowledged the central issue.
“For our system to work, you and the investing public must have confidence that the fees we are paid, regardless of the nature of that work, will not weaken our resolve to do what is right and in the best interests of investors,” C.E. Andrews, who was at the time global head of auditing and business advisory for Andersen, said in testimony to Congress in 2001.27
In a 2004 article in The Journal of Corporation Law titled “The Mother of All Conflicts,” law professor Richard Kaplan of the University of Illinois described his experience long ago as a junior auditor at a big accounting firm.
“The accounting firm culture held that making trouble for a client was the road to professional oblivion,” Kaplan wrote. He continued:
After all, the audit personnel who were the subjects of praise and admiration were the ones who earned the highest epithet: “He ... knows how to keep clients happy.” Experts in the intricacies of financial accounting standards were regarded with much less awe. Indeed, their principal utility seemed to lie in formulating hypertechnical rationalizations that would provide nominal compliance with “generally accepted accounting” precepts while enabling the client to do what it intended. That, apparently, was how you kept a client “happy.”28
POGO’s reporting has shown what the big accounting firm PricewaterhouseCoopers (PwC) expected of an auditor in Silicon Valley more recently. In written feedback on his performance, PwC partners explained what it would take for the auditor to advance at the firm. “Build the relationships where the client would never want to leave PwC,” the feedback said. “As a partner you have to have the position that you want these guys to like you,” the document from 2014 added.29
At big audit firms, a partner’s “primary source of job security is the partner’s ‘book of business’ or client list,” Robert A. Conway, a former audit partner at a major firm, wrote in his 2020 book, The Truth About Public Accounting: Understanding and Managing the Risks the Auditors Bring to the Audit.30
“This means there is a lot of pressure on each partner to keep their existing base of clients. This pressure can create tension between ‘keeping the client happy’ and good audit quality,” Conway wrote.31
The accounting firm Grant Thornton made a similar point in a 2011 statement to regulators.
“No partner wants to be the one to lose a significant or long-standing relationship,” Grant Thornton wrote.32
The fundamental conflict of interest is bad enough, but there are also exacerbating factors.
Audit firms do more than audit; they sell other services to corporations. That puts them in the position of soliciting business from companies they must be willing to antagonize. It also puts them in the position of having to objectively assess business results they helped shape. Though it’s subject to restrictions, it complicates an already fraught relationship.
In addition, some individual auditors are, in a manner of speaking, selling themselves. Many accountants have used auditing as a stepping stone to employment at companies they’ve audited, and many companies have hired from the ranks of their auditors.
“Another aspect of the patronage system that characterizes the auditing institution is the alumni effect where [companies] hire partners or managers of the auditing firm. The problem is that they will hire only the ones they consider ‘played ball’ with them,” Ketz said.33 There’s a one-year cooling-off period for auditors going to work for companies they audited, but that’s too short, Ketz added.34
Then there’s the incentive for audit firms to cut corners — to boost their profits by skimping on the time, effort, and labor spent performing an audit — for example, by relying heavily on junior auditors and stretching them too thin.35
In sum, the auditing system does the opposite of what Madison advocated in his treatise on checks and balances. When it comes to the relationship between auditor and client, ambition can further ambition.36
Trust in audits has long been a leap of faith.
At a 1933 hearing, before Congress drafted the audit requirement, an accountant named Arthur Carter urged Congress to entrust the work to public accountants.37
“Who audits you?” a senator asked.
“Our conscience,” the accountant replied.
The senator asked how an auditor differed from a corporate controller.
The controller “is in the employ of the company,” Carter responded.
It was a subtle distinction, and the auditor’s conscience has at times proven a weak match for other motivations.
For example, in 2019, the SEC charged the accounting firm KPMG with engaging in rampant self-serving dishonesty. KPMG agreed to pay a $50 million penalty and admitted to the facts laid out in an SEC enforcement order.38
In a related news release, the SEC said “numerous KPMG audit professionals cheated on internal training exams by improperly sharing answers and manipulating test results” and that the cheating “included lead audit engagement partners who not only sent exam answers to other partners, but also solicited answers from and sent answers to their subordinates.” 39
The SEC also said senior members of the firm improperly obtained and used confidential information about which of KPMG’s audits regulators planned to inspect. The SEC had earlier compared that to “stealing the exam.”40
“The breadth and seriousness of the misconduct at issue here is, frankly, astonishing,” Steven Peikin, co-director of the SEC’s Enforcement Division, said in an SEC news release.41
In related cases, several accountants were convicted of or pleaded guilty to criminal charges.42
If enforcement actions are any guide, there’s been an outbreak of cheating at big accounting firms.
In September 2021, the U.S. audit oversight board charged that, at KPMG’s Australia affiliate, more than 1,100 employees, including more than 250 auditors, “were involved in improper answer sharing — either by providing or receiving answers — in connection with tests for mandatory training courses” on topics such as professional independence, auditing, and accounting.43
In February 2022, the same regulator charged that, at the PricewaterhouseCoopers (PwC) affiliate in Canada, more than 1,200 professionals engaged in similar misconduct.44
The KPMG and PwC affiliates settled those cases without admitting or denying the charges. That has been typical in SEC and PCAOB enforcement actions.45 Unless otherwise noted, SEC and PCAOB charges against auditors cited in this report followed that pattern.
Last year, the SEC charged another big accounting firm, Ernst & Young, with improperly using an inside track to win appointment as auditor of a Fortune 500 company. EY sought and received confidential information from an insider at the company — the company’s chief accounting officer — about competing bids and the company’s selection process, the SEC said.46
EY also helped draft the company’s request for proposals from audit firms, the SEC said.47
Internally, EY explained how some of the conduct at issue gave it an advantage, according to an SEC disciplinary order.
“An internal EY victory ‘case study’ prepared shortly after EY was awarded the ... audit described this access as a ‘head start none of the other firms were given,’” the SEC said in a disciplinary order.48
In June 2022, the SEC charged EY with new violations, saying hundreds of EY auditors cheated on tests required to obtain and maintain accounting licenses — including ethics exams. The SEC also charged EY with withholding evidence from the agency during its investigation.
“EY audit professionals’ repeated cheating on exams and the firm’s misrepresentations to the SEC violated ethics and integrity standards and discredited the accounting profession,” the SEC said in an enforcement order.49
In that case, EY admitted the SEC’s allegations and agreed to pay a penalty of $100 million.50
None of this suggests the public should count on accountants’ integrity to protect them.
Better to leverage auditors’ self-interest.
Congress and the Securities and Exchange Commission (SEC) mandated independent audits for public companies in the 1930s, after the stock market crash of 1929.51
The government created a massive cash cow for the accounting industry, and it compelled corporations to buy the milk. It forced shareholders to pay for it. But what are shareholders getting for their money?
Federal rules spell out with specific illustrations what the government means by “independent.”52
For example, accounting firms and individual accountants within those firms may be disqualified if they hold stock in a client company, borrow money from a client company, or have any direct business relationship with a client company.53
There are exceptions. For instance, it’s okay for an auditor of a bank to have a car loan from the bank, provided the loan was obtained on normal terms and is collateralized by the car. It’s okay for an auditor of an insurance company to have an insurance policy from the insurer, provided the auditor wasn’t associated with the audit firm when the policy was issued and the “likelihood of the insurer becoming insolvent is remote.” 54
But what happens if the likelihood changes over time? And why is the likelihood of insolvency an appropriate standard at all, given that the auditor could be called upon to opine on that very point — the likelihood of the client becoming insolvent?
With respect to the car loan, why focus on the stated criteria when in the event of default, the loan company remains in a position to repossess the car — or not?
And, of course, the prohibition on business relationships doesn’t prohibit the accounting firm from providing various professional services to the audit client.
In other words, the so-called auditor independence rules require mental gymnastics.55
Audit firms have couched audit reports on individual companies accordingly. For example, a report by one firm says it is “required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.”56
The SEC rules include this overarching provision:
The Commission will not recognize an accountant as independent, with respect to an audit client, if the accountant is not, or a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the accountant is not, capable of exercising objective and impartial judgment on all issues encompassed within the accountant’s engagement. In determining whether an accountant is independent, the Commission will consider all relevant circumstances, including all relationships between the accountant and the audit client.57
All, it seems, but the most obvious: the accounting firm works for its client. As others have noted, under the current system, any reasonable person taking the SEC standard quoted above at face value could reasonably conclude that no auditor qualifies as independent.
As it turns out, as lax as the independence rules may be, audit firms have still had trouble complying with them — as Ketz noted in “The Myth of Auditor Independence.”58
The alleged violations make a mockery of the rules.59 But that’s not all. They give further proof of why the public shouldn’t simply put its trust in auditors to do the right thing. They show where the incentives can lead.
For instance, in 2019, the Public Company Accounting Oversight Board took enforcement action against accounting firm Marcum LLP, saying it violated independence rules with respect to 62 companies.60 Marcum hosted an annual conference for investors at which it “expressly touted” companies it audited as high-quality investments, the regulator said.61 That “created a mutual interest” between Marcum and its clients in seeing that the companies “lived up to Marcum’s billing,” the PCAOB said.62
PwC has been cited as a repeat offender. In 2002, the SEC accused PwC of violating the rules with 16 audit clients over a five-year period, rendering their financial statements invalid.63 In 2019, the SEC accused PwC of violating the rules again.64
Also in 2019, the SEC accused accounting firm RSM US of violating independence rules in connection with more than 100 audits.65
In 2014, the SEC charged KPMG with violating the rules with respect to three companies it audited.66 Among the alleged violations: KPMG employees owned stock in one of the companies.67
In 2014, the SEC charged Ernst & Young with violations for claiming it was independent of two companies at a time when it had been lobbying congressional staff on their behalf.68 In December 2021, the SEC charged three Ernst & Young personnel with independence violations in relation to Cintas, another company Ernst & Young was auditing.69 The SEC said Ernst & Young did tax work for Cintas on a contingency fee basis — charging a percentage of tax benefits the accounting firm helped Cintas secure — which is against the rules.70
Then there was the 2016 case against Ernst & Young, which took the auditor-client relationship to a different level. One EY partner became “romantically involved” with a client company’s chief accounting officer, and another “maintained an improperly close friendship” with the company’s chief financial officer, the SEC said.71
When the company was considering dropping EY as its auditor, the second of those partners, Gregory S. Bednar, was assigned to head the audit team and “was specifically tasked” by EY “to improve its relationship” with the company.72
Soon, Bednar and the company’s CFO were staying overnight at each other’s homes and taking family trips together. They traveled out of town to attend events together — including a football playoff game, a hockey game, and the Masters golf tournament. The expenses for Bednar’s entertainment exceeded $100,000, the SEC said.73
When a senior partner at the audit firm informed Bednar that the firm would be unable to pay for certain expenses, the partner nonetheless thanked Bednar for his “continued focus on building long lasting client relationships,” the SEC said.74
A 2018 SEC enforcement action against audit firm Crowe LLP further showed why an independent mindset — or the lack thereof — matters.75
Crowe audited a temporary staffing company called Corporate Resource Services (CRS).
For the 2013 fiscal year, Crowe asserted that it met the independence requirements and gave CRS a clean audit opinion.76
However, Crowe did not qualify as independent, the SEC said. Crowe was in business with CRS. While it was auditing CRS, Crowe was subcontracting employees from CRS and farming them out as consultants to Crowe clients, the SEC said.77
Crowe performed a deficient audit, the SEC said. For example, though Crowe identified a risk of fraud at CRS involving a related company that handled CRS’s payroll taxes, Crowe did not obtain any supporting documentation for amounts that company billed CRS, the SEC said.78
CRS “went bankrupt in 2015 after the discovery of approximately $100 million in unpaid federal payroll tax liabilities,” the SEC said.79
No Time for Complacency
Some might argue that there’s nothing to worry about because, while there have been Enron-like accounting debacles in other countries, there haven’t been any new Enrons in the United States recently.
They might argue that the situation has improved in the 20 years since Congress — in response to Enron, WorldCom, and a series of other corporate accounting scandals — created a regulator just for auditors, the PCAOB, and made other regulatory changes.
They might point to a long but recently reversed downward trend in “restatements,” a euphemistic term for corrections companies publish when their financial statements turn out to have been wrong.80
Despite the enduring lack of auditor independence, it’s possible that auditing has improved. But getting complacent would be a mistake. It would ignore a variety of troubles.
For example, the financial crisis of 2008, the related meltdown of major financial firms, and systemic problems in the mortgage industry unfolded after the post-Enron reforms were implemented.
So did Bernie Madoff’s epic Ponzi scheme, which devastated many victims. Madoff’s firm wasn’t audited by a major accounting firm, but entities that invested in it — so-called “feeder funds” — were.81
Wells Fargo, the big bank, was exposed as abusing customers on a large scale and suffered major consequences, yet its internal controls had received clean audit opinions.82 The company’s auditor, KPMG, acknowledged in 2016 that it “became aware of instances of unethical and illegal conduct by Wells Fargo employees, including incidents involving these improper sales practices,” but asserted that its audits had been performed appropriately.83
Within the past two years, the SEC has charged such well-known companies as General Electric and Under Armour with misleading investors.84 Without admitting or denying the charges, GE agreed to pay a $200 million penalty, and Under Armour agreed to pay a $9 million penalty.85
Over the years, the PCAOB’s annual inspections of major audit firms have found that many audits failed to meet regulatory standards.86
As recently as August 2022, the oversight board cited problems in audits of brokers, dealers, and broker-dealers — categories of financial firms that make up much of Wall Street. While inspections over the past 11 years show improvement, “the overall deficiency rates remain unacceptably high,” the board reported.87
“Some of these deficiencies have been observed during inspections on a recurring basis for many years,” the board added.88
The downward trend in corporate accounting restatements, which spanned 2006 through 2020, came to an abrupt end last year when corrections spiked, according to data compiled by Audit Analytics, a research firm.89 In 2021, the number of restatements nearly quadrupled, rising to its highest level since 2006. The increase was driven by a proliferation of companies using a relatively new business model and guidance from regulators about how those companies should have been keeping their books, Audit Analytics said.90
The accounting problems that lead to restatements don’t appear to be entirely random. Look closely at the Audit Analytics data, and you can see a chronic pattern: restatements tend to reduce corporate profits more than they increase reported profits. In other words, the bad accounting tended to make the companies look better.91
Though the number of restatements is sometimes cited as a barometer of auditing quality or of the overall quality of corporate financial disclosures, it’s a crude one.
One of the main reasons the number of restatements declined over the past decade is that the number of companies registered with the SEC declined, Audit Analytics said.92
If you dismiss the latest spike as an anomaly, the earlier decline in restatements might indicate that auditors are doing a better job and having a prophylactic effect. However, there could be other explanations. There could be fewer errors to catch — or auditors could be catching fewer errors. Or, when they spot problems, auditors could be going easier on their clients.
“Companies are increasingly likely to correct accounting problems by quietly updating past numbers, rather than alerting investors and reissuing financial statements,” The Wall Street Journal reported in 2019.93
Francine McKenna — author of The Dig newsletter, veteran of big accounting firms, and longtime audit analyst — says something similar has been happening in the realm of enforcement. The SEC and the Justice Department have been letting companies and executives get away with more, McKenna said.
“There’s been sort of this gradual slide down the hill that says, ‘We are not going to call people out any more. We are not going to admit that people are cheating,’” McKenna said on the Crypto Critics’ Corner podcast.94
A lot of accounting problems may not come to light until there’s another recession, some observers say.
“That’s because economic expansions supply firms with many avenues to contort and invent revenues,” Ketz, author of “The Myth of Auditor Independence,” told POGO. “When we do go into the next recession, let’s see what happens. My bet is that when that happens, the scandals will occupy a large space of the business news media,” Ketz, a scholar at Penn State, said by email.95
Howard Schilit specializes in scrutinizing corporate financial reports for investment firms and wrote the book, Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports. He has no shortage of work.
“I think the auditors have probably gotten no better and probably worse,” Schilit told POGO.96
“They have so narrowed the scope of what they believe they are responsible for that it renders their opinion, in my judgment, almost meaningless,” Schilit said.97
Schilit faults auditors for not calling out companies that mislead investors by using creative financial metrics that do not conform to accounting rules.
Meanwhile, audits may be more important today than they were 20 years ago, when the post-Enron reforms were enacted, said Lawrence A. Cunningham, a professor at George Washington University Law School and director of the school’s research program on corporate governance.98
That’s because the “shareholder demographic” has changed, Cunningham said in an interview with POGO. In the past, “a very large critical mass” of institutional investors had analysts evaluating individual companies. However, there has been a shift toward index funds, which invest in broad market indices like the S&P 500 instead of picking stocks, Cunningham said. Those funds have neither the need nor the staff to scrutinize the accounting of individual companies.99
“It’s a disaster from a systemic perspective, because you have no one watching the store,” Cunningham said.100
Also, in recent years, increasing numbers of individuals have been playing the market, Cunningham said.101
While Enron may be a fading memory, overseas, accounting scandals have led to the collapse of major corporations and cast a spotlight on auditors in recent years. The fact that they’ve occurred abroad and not here is cold comfort.
One such scandal involved Wirecard, based in Germany.102 It is a case study.
In 2020, Wirecard issued an extraordinary statement, revealing that about $2 billion it supposedly had on hand was apparently an illusion.
“The Management Board of Wirecard assesses on the basis of further examination that there is a prevailing likelihood that the bank trust account balances in the amount of 1.9 billion EUR do not exist,” the company said.103
As a chronology compiled by the Financial Times put it, the announcement showed “the potential scale of a multiyear accounting fraud.”104
Wirecard filed for the German equivalent of bankruptcy, the Wall Street Journal reported. The missing $2 billion was “equivalent to the company’s entire profit over more than a decade,” the Journal reported.105
Ernst & Young audited Wirecard “for more than a decade and provided unqualified audits until 2018,” the Financial Times reported.106 A whistleblower warned EY of fraud at Wirecard four years before the company collapsed, the Financial Times reported.107
“Many people believe that the fraud at Wirecard should have been detected earlier and we fully understand that. Even though we were successful in uncovering the fraud, we regret that it was not uncovered sooner,” EY’s Global Chairman and Chief Executive Carmine Di Sibio said in September 2020, according to a Reuters report.108
Whatever the root causes of the Wirecard debacle may be, the regulatory system the United States put in place for auditors 20 years ago failed to avert it.
In 2019, the PCAOB issued an inspection report on Ernst & Young’s German affiliate, Ernst & Young GmbH Wirtschaftspruefungsgesellschaft, saying the regulator reviewed the firm’s work on three audits and identified no defective audits.109
In a 2019 letter to the PCAOB, leaders of the accounting firm wrote, “We are pleased that no audit performance issues are identified within the report.”110
What are the alternatives?
What can be done to remove or mitigate auditing’s fundamental conflict of interest?
The system now in place relies on a patchwork of counter-measures. The PCAOB inspects audit firms, but the inspections are largely lacking in transparency.111 The PCAOB has the power to enforce audit rules, but, as a POGO investigation has shown, its disciplinary record is feeble.112 At times, the PCAOB appears to have been captured by the audit industry.113
The KPMG “stealing the exam” scandal showed that, worse still, the oversight board had been corrupted. PCAOB personnel leaked confidential information to KPMG or brought inside information to KPMG when seeking or assuming more lucrative jobs at the accounting firm.114
The PCAOB answers to and shares authority with the SEC. The SEC office that oversees auditing and accounting — the Office of the Chief Accountant — has been staffed by a revolving door of personnel from big accounting firms.115
It’s long past time to think outside the prison of the status quo.
The following are several approaches that could change the relationship between the auditors and the audited. They may not be mutually exclusive. Some could be used in combination with others. Some have been aired previously in academic and policy circles, and others have not. Some would upend the current system, while others would change it more modestly.
Though we identify potential advantages and disadvantages of each, we present them without endorsement.
Government Does The Audits
Instead of delegating auditing to a private, for-profit industry, the government could do the auditing itself.
The watchdog role auditors are supposed to play is arguably a regulatory one.
There are parallels. To protect the food supply, the Department of Agriculture deploys meat inspectors. To safeguard the banking system and federally insured deposits, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp., and the Federal Reserve deploy bank examiners. To make sure nuclear power plants are operating safely, the Nuclear Regulatory Commission employs its own inspectors. To promote compliance with tax laws, the Internal Revenue Service audits individuals and companies.
To protect airline passengers and crew, the Federal Aviation Administration recently said it would perform final inspections on new Boeing 787 Dreamliner jets instead of allowing Boeing, the manufacturer of the planes, to certify their airworthiness, according to news reports by Reuters and others.116
How well those government efforts work is a reasonable question. They have weaknesses and vulnerabilities.
Federal regulators are hardly impervious to improper influence. Regulators can be captured, and vested interests can exert political influence on regulators through Congress and the executive branch. In the infamous Keating Five scandal, senators who received political contributions from Charles Keating intervened with regulators scrutinizing Keating’s Lincoln Savings and Loan Association. Keating later pleaded guilty to crimes, and Lincoln collapsed during the S&L crisis at a cost of billions of dollars.117
Congress controls the purse strings of federal regulators, and one way that industries can undermine regulators is to target their budgets.
Any team of government auditors would have to be adequately funded, and it could take a lot of government auditors to audit all the corporations listed on U.S. stock markets.
Some might question the government’s ability to attract enough auditors with the requisite training, but over time demand can create its own supply. If accountants wanted a career auditing public companies, the government would be the only place to go.
Cutting out the accounting firms could remove costs from the system. Society wouldn’t have to pay for partner profits or marketing expenses, such as entertaining clients.
“Until the SEC has its own corps of financial investigators who routinely examine a corporation’s financial statements, the basic conflict of interest you described will remain,” Richard Kaplan of the University of Illinois told POGO.118
“The government has its own auditors for something it cares about – namely, its tax revenue. If the government cares enough about the integrity of financial statements, it should do likewise,” Kaplan said.119
Still, politically, creating another government bureaucracy could be a tough sale.
Armed with the wealth and power that flows from its lucrative franchise, the auditing industry can be counted on to defend that franchise.
The auditing industry has guarded its claim to corporate auditing in part by arguing that Congress carefully studied and rejected the idea of government auditors in the 1930s.120 But that’s a myth, Michael E. Doron, an associate professor of accountancy at California State University, Northridge, has written.
“The United States has never witnessed a real debate over the role government should play in the audits of publicly traded companies’ financial statements,” Doron wrote. “The financial statement audit was hastily delegated to the accounting profession with little debate more than 80 years ago, when the Securities Acts were written.”121
“The frequent mischaracterizations of these events through the past eight decades have handicapped discussion of this issue, allowing it to be dismissed as outside the mainstream of American practice,” Doron wrote in a historical study. “It has also allowed the accounting profession to claim that its seat at the table of Wall Street regulation was earned, not hastily and reluctantly granted.”122
Government Hires Auditors
Another option would be for a regulatory agency to assign audit firms and pay them with money collected from corporations.
Cal State’s Doron advocated that approach in a 2019 article in The CPA Journal.
Doron said an experiment in a state in India showed the potential benefits of using a “third-party payer.” The experiment involved environmental protection. Industry practice “had been the same as for financial statement audits: an outside firm was hired to inspect and report on the level of pollution by regulated plants,” Doron wrote. The system “failed to provide meaningful enforcement, because the inspectors had no incentive to issue negative reports on the plants that hired and paid them,” Doron wrote.123
However, when industrial plants were randomly assigned an auditor and auditors were paid from a central pool, the quality of inspections improved, researchers found. Among other improvements, “plants reduced their pollution emissions,” Doron wrote.124
Doron proposed that the PCAOB assign and pay the audit firms. The oversight board already collects fees from publicly traded corporations to fund itself, he noted, and could piggyback on that system.
Doron laid out a variety of arguments for an official third party, such as the oversight board, to choose and pay the auditors.
The idea came up at a 1933 hearing, he said. A senator suggested letting the Federal Trade Commission pick the auditors. As recently as 2018, the accounting firm Grant Thornton endorsed the concept in the U.K., recommending that a public body select auditors for large companies.125
As a second-tier audit firm, Grant Thornton could benefit from such an arrangement. It could help smaller accounting firms gain business from the so-called Big Four that dominate the auditing of major corporations. That could serve the useful purpose of increasing competition.
The PCAOB could use its discretion, leaving auditors in place if they are doing well or replacing them if they are doing poorly. Through its inspections — however flawed those might be — the oversight board has a window into auditor performance. In addition, or alternatively, the PCAOB could rotate auditors after a set number of years (more on that below).
The oversight board could also adjust the audit fees. That could counter the risk that audit firms would lowball their fees to win business and then cut corners on the audits.
In the U.S. corporate world, the vested interests — audit firms and their clients — could be counted on to oppose this model. They would no doubt argue that it undercuts the role of corporate boards of directors — and boards’ audit committees — as overseers of outside auditors.
But boards are part of the company. If they weren’t, we might not be having this discussion. The interests of board members are closely aligned with those of corporate management, especially if they get paid in stock or stock options and if they want to keep their board seats. There’s no reason to think board members bring more expertise or independence to the task than a third party could muster.
“Most audit committees continue to seek a recommendation from management about auditor retention — and most auditors know that,” Robert A. Conway, a former PCAOB official and Big Four audit partner, said in an email to POGO. The “so called” independent audit committee members “are often not as independent as they should be. These individuals frequently want to stay in good favor with the CEO (who in many instances, likely had something to do with each audit committee member’s appointment to the Board of Directors),” Conway said.126
The third-party plan poses less of a threat to the accounting industry than having government do the audits because it would leave the private accounting firms and their coveted franchise intact.
The proposal’s biggest weakness may be that it depends on a third party, such as the PCAOB, to avoid being captured by the auditing industry or the corporations.
Doron envisioned that a corporation, including its board or audit committee, “would be free to voice concerns to the PCAOB.”127 However, for the third party administering the system, falling under the influence of the corporations could be just as damaging as falling under the influence of the auditors.
Stock Exchanges Hire Auditors
Could some other authority play the third-party role — assigning, reassigning, and disbursing payments to audit firms?
Stock exchanges might be candidates. They maintain standards for listed companies.
In 1933, even before the government mandated independent audits, the New York Stock Exchange adopted such a requirement for companies seeking to be listed.128
In theory, a stock exchange could use the promise of good audits to attract investors. It could use the promise to inspire greater investor confidence in the financial disclosures of companies whose shares trade on the exchange.
But stock exchanges have conflicts of interest of their own. They make money, including listing fees, from listed companies.129 They have an interest in attracting and keeping companies. That could translate into an incentive to make audits less costly, burdensome, or threating to companies. It could also translate into an incentive to keep share prices up — instead of puncturing illusions.
Stock exchanges “may prefer pleasing their listed members to safeguarding the interests of long-horizon investors,” Joshua Ronen, a professor of accounting at New York University’s Stern School of Business, has written.130
The Insurance Model
Ronen proposes a different solution, one centered on insurance.
With a variety of moving parts, it is far from a model of simplicity, and the summary below does not cover all of its complexities.
Under this plan, a company would have the option of seeking an insurance policy that would pay investors for losses in the event that the company’s financial statements turned out to be false.
“Companies would select an external auditor from a list of audit firms approved by their insurance carrier,” Ronen says. “The auditor would be hired and paid by the insurance carrier, but the audit fees would be reimbursed” by the company that’s being insured.131
The insurance coverage would take effect for a particular year’s financial statements only if the financial statements passed an audit. The size of a company’s insurance policy and the amount it pays for the coverage would be publicized, allowing the public to see how much confidence the insurer has in the company’s financial statements.
Under Ronen’s plan, the insurance companies could establish their own audit firms, increasing competition in the audit business.
Ronen’s plan flows from a familiar indictment of the current system:
I am arguing that the intractable conflict of interest imposed on auditors cannot be rectified through legislation, regulation, enforcement, or litigation as long as auditors are engaged by the management of the firms they audit. Instead, what is needed is an agency relationship between the auditor and an appropriate principal whose economic interests are aligned with the goals of promoting better disclosures and greater economic efficiency.132
As Ronen sees it, under the insurance model, the key players would have healthy incentives:
Once an insurer has underwritten a financial statement insurance policy, the insurer’s objective would be to minimize the cost of claims against the policy — that is, the insurer’s incentives would be aligned with those of investors. Towards meeting this objective, the insurer would provide incentives to its hired auditor to exert optimal effort, improving the financial statement’s quality in the process. ... Auditors, having been hired by the insurers, would want to build reputations for high quality. Their independence, both real and perceived, would be enhanced.133
This plan assumes that insurers would be willing and able on a large scale to take on the massive financial liabilities that could result from corporate accounting meltdowns like Enron.
It seems possible that the plan could create or preserve incentives contrary to those intended. Once auditors have given a company’s financial statements their stamp of approval, and once insurers have insured them, each could have an incentive to avoid bringing to light any problems that would trigger expensive insurance claims.
The interests of insurers and the interests of the public are not necessarily aligned. One way insurers can increase profits is by trying to minimize payouts. That will come as no surprise to anyone who has fought to get an insurer to pay for medical bills, or car repairs, or a house lost to disaster.
In an email to POGO, Ronen dismissed those worries.
Under Ronen’s plan, the auditor is hired by the insurer “and does the latter’s bidding,” Ronen said. The insurer would not have incentives to hide problems discovered by the auditor because that would “amount to aiding and abetting fraud, subjecting the insurer to potentially catastrophic liability,” Ronen said.134
Eliminate the Audit Requirement
Here’s a radical alternative: Eliminate the audit requirement.
Lynn Turner, a former auditor, former chief accountant at the Securities and Exchange Commission, and longtime critic of the audit industry, thinks that would be an improvement.135
At least as part of a larger plan.
Companies that procured optional audits might be sending a message to the investing public that they have nothing to hide — assuming the investing public values the audit and views it as more than window-dressing.
Instead of relying on audit fees as an entitlement, audit firms might have to earn them.
Mix and Match Options
With or without the audit requirement, there are a variety of reforms that could leave auditors less entrenched.
Turner would have shareholders vote every five years on whether their company should procure an audit and, if so, on whether to approve the company’s choice of auditor. Turner advocates this approach in part “to establish accountability to investors as owners of the company.”136
Under Turner’s plan, the PCAOB could require a company to put the audit up for bid if the PCAOB found that the auditor had committed malpractice. Audit firms would be limited to 20-year terms.
“Quite frankly, what’s been tried so far hasn’t worked. That’s the one thing we know,” Turner told POGO.137
Turner emphasizes that, under his plan, the audit committee of the board of directors, not corporate managers, would nominate the auditor and negotiate the auditor’s fee.
If anything, Turner’s plan might not be enough of a departure from the status quo. Under the current system, audit committees of corporate boards are supposed to oversee audit matters,138 but Turner himself has written that, too often, audit committees “delegate hiring and oversight of the auditor to management.”139
In an interview, Turner said the rules requiring audit committees to oversee auditors themselves must be tightened and enforced.140
Assuming shareholders would generally vote to procure audits, as Turner expects, it’s unclear what else would keep audit committees of corporate boards from relying on or taking their cues from corporate managers.
And if shareholders abandoned audits, where would we be? Flawed though audits may be, do they provide at least some check on corporate financial reporting?
Eliminating them could ratchet up the burden of “buyer beware.” Investors would be even more on their own to see through any false or phony accounting.
The chief executive of a private technology company proposed another option that turns to shareholders: Give every shareholder that owns at least a 5% stake in a public company the right to audit the accounts at their own expense. The CEO, who didn’t want to be quoted by name, offered the proposal in an email to POGO. “Isn’t it their company and therefore their data after all?” the executive asked.
Another idea we’ve heard discussed is to make corporate executives face strict liability for false accounting. In other words, if the books turn out to be cooked, or if the accounting is materially wrong, their heads would be on the legal chopping block. Whether or not they were directly implicated in wrongdoing, they would be held responsible. To protect themselves, the theory goes, executives would demand that the auditors scrub everything thoroughly.
For that to work, executives couldn’t hide behind the auditors. They couldn’t claim as a legal defense that the auditors — the so-called experts — found that everything was okay.
Another radical idea: Turn the incentives 180 degrees.
As an occasional backstop to current audits, allow a third party to come in and, on a contingency-fee basis, look for problems.
This new team would be rewarded for exposing fraud or error. We’ll call it a red team.
Asked to suggest solutions to the conflict-of-interest problem, Michael Flaherman proposed the idea in interviews with POGO.141 Flaherman is an anti-corruption consultant, a former private equity executive, and a former board member of CalPERS, the California Public Employees’ Retirement System. CalPERs, a big investor of pension money, has long taken an interest in corporate accountability.142
As Flaherman envisions it, every three or five years a company would hire a red team the same way it hires auditors. Like an auditor, the red team would have full access to the company’s books and records. It would produce a report on its findings that would be filed with the SEC along with the company’s annual financial report.
If the red team’s findings required the company to restate financial results, the company would pay the red team a fee based on the size of the restatement. If the red team found a problem that was significant but unrelated to accounting, the company would pay a fixed-price bounty based on a schedule set out in advance.
Flaherman identified a pitfall: If the red team found a problem that was so serious it could kill the company — “a death-penalty problem” — the red team would be incentivized to sweep that under the rug, lest the company land in bankruptcy and the red team have trouble collecting its fee.
What incentive would a company have to hire a tough red team?
Flaherman called that the biggest weakness. It might be mitigated, he said, if red teams were required to publish their track records — for example, information about the restatements they’ve secured — and if the selection of the red team was put to a shareholder vote.
Alternatively, a third party, such as a regulatory agency, could assign red teams, as the author of this report’s child Joey Hilzenrath suggested in conversation.143
Restrict Audit Firms to Auditing
What if audit firms did nothing but audit?
In the United Kingdom, a long-running debate over how to reform auditing has focused largely on all the other things accounting firms do for corporations.
As some people see it, the crux of the independence problem is that audit firms don’t just audit; they also sell an array of consulting services to corporations. Figuratively speaking, that can leave watchdogs at the front door begging for treats, a posture at odds with their mission.
In 2019, a study by an arm of the U.K. government called for an “operational split between the audit and non-audit practices of the Big Four.”144 That was a reference to the four dominant firms, Deloitte, Ernst & Young (EY), KPMG, and PricewaterhouseCoopers (PwC). The split would involve essentially compartmentalizing the two aspects of the firms’ businesses.
“The aim of this is to ensure auditors’ full focus is on conducting high quality audits,
without their incentives being affected by the much greater revenue and profits from
the non-audit side of the firm,” the study said.145
In March 2021, the U.K. government proposed a more modest step. It floated a plan to create “independent Audit Boards within firms” to govern the audit practices.146
A group of advocacy organizations urged the U.K. government to go farther.
“To truly end conflicts of interest we urge the government to back full structural separation, so that audit and non-audit services are carried out by separate companies,” the group147 said in a joint statement.148
Now, EY is preparing to do something along those lines. Subject to a vote by thousands of EY partners, the firm plans to split itself in two.149 The result may not be a clean break between auditing and consulting; reportedly, the surviving audit firm might continue to provide some non-audit services.150
Regardless, neither EY’s split nor any variations on the theme would truly end conflicts of interest, because audit firms would still be paid by the companies they audit. If audit firms were purged of non-audit work, they would be wholly dependent on their audit clients.
Nonetheless, requiring audit firms to focus exclusively on auditing — establishing pure audit firms — could advance the public interest for other reasons.
The first involves the shortsighted nature of U.S. auditor independence rules.
Though the rules limit the range of non-audit services accounting firms can provide for companies they audit, the limits leave plenty of room for trouble. For example, there is no prohibition on audit firms advising their clients on business strategy. In addition, though firms are under certain circumstances prohibited from selling their audit clients aggressive tax avoidance strategies, they are allowed to do so under other circumstances — for example, if those strategies are deemed more likely than not to survive legal scrutiny.151
More to the point, U.S. auditor independence rules myopically focus on the work that audit firms do for their audit clients. Though it may seem counterintuitive, the work they do for other companies can pose conflicts of interest, too.
If an audit firm is in the business of selling tax avoidance strategies — if it sells tax reduction schemes to companies B, C, and D, which are not audit clients — can it objectively judge the use of similar strategies by Company A, which is an audit client? 152 Or does it have a vested interest in promoting such schemes and seeing that they succeed?153
What’s more, the fact that audit firms serve as consultants to companies poses other problems. In a world where four international firms dominate the auditing of large corporations, consulting relationships limit competition among auditors and companies’ ability to switch auditors.
Say Company A is interested in replacing Deloitte as its auditor. If EY, KPMG, and PwC have consulting relationships with Company A, those relationships could disqualify the three firms from auditing Company A. They could discourage the three firms from even bidding to become Company A’s auditor. The three firms might prefer consulting to auditing, they might find it more lucrative, and they might be loath to give up the consulting contracts. Even if only one or two of the firms have consulting relationships with Company A, those relationships could limit Company A’s options.154
Term Limits for Auditors
Term Limits — The Theory
That brings us to a proposal that has received more attention than any other: Term limits for auditors, also known as mandatory rotation of audit firms.
Some companies have relied on the same audit firm for decades. GE, a repeat offender on the financial reporting front, employed the same firm for more than a century.155 For the audit firms, these audits can become an annuity. The already cozy relationship between the audit firm and its client can become even cozier.
As we’ve said before, once an audit firm has given a “clean” or “unqualified” opinion to financial statements that include fraud or error, the audit firm owns the problem. It has a perverse incentive not to expose the problem, because exposing the problem could expose the firm to liability.156
The theory is that auditors would approach their work differently if they knew another firm was going to be taking over, reviewing the accounting, and making a clean sweep — lest it, too, own the problem. The theory is that an audit firm would have less incentive to bend to the client if it knew its term was limited. And the theory is that, every now and then, it would help to have fresh eyes on the accounting.
Powerful arguments all.
The European Union, the U.K., and South Africa have in recent years adopted versions of this requirement.157 It’s too early to learn much, if anything, from their experience.158 Indeed, there’s precious little consensus on how to measure audit quality, let alone how to measure the impact of any policy change. In the European Union and the U.K., terms as long as 20 years are still permitted, so any benefit from mandatory rotation might be attenuated. South Africa’s requirement begins to take effect next year.
Howard Schilit, the accounting sleuth, said he views five-year term limits as “the short-term best fix to the problems at hand.”159
The “culture of the CPA firm has always been not to piss off clients,” Schilit told POGO. “It’s much more difficult to change long-term behavior patterns than it is to change rules, but I think over time you could be hopeful that the behavior also changes.”160
Term Limits — The Early History
In the United States, audit firms have fought the idea of mandatory rotation for decades, after each new crisis has focused attention on their performance. That history, which the PCAOB has recounted,161 may say more about the audit industry than it does about the merits of mandatory rotation.
In the 1970s, after a series of corporate scandals, a Senate panel published a report on what it called “The Accounting Establishment.” That searing critique — also known as the “Metcalf Report,” after a senator named Lee Metcalf — found that a long association between a corporation and its auditor “may lead to such close identification of the accounting firm with the interests of its client’s management that truly independent action by the accounting firm becomes difficult.”162
“One alternative is mandatory change of accountants after a given period of years, or after any finding by the SEC that the accounting firm failed to exercise independent action to protect investors and the public,” the Metcalf Report said.163
The American Institute of Certified Public Accountants, a lobbying group and trade association for accounting firms, answered by commissioning a study of its own, by a panel it convened called the Cohen Commission. (Despite its official-sounding name, it had no governmental authority.)
The Cohen Commission argued against mandatory rotation.
“Since the cost of mandatory rotation of audit firms would be high and the benefits that financial statement users might gain would be offset by the loss of benefits that result from a continuing relationship, rotation of firms should not be required,” the Cohen Commission said.164
After Enron, a series of observers called on Congress and the SEC to impose term limits on auditors.165
Advocates included the AFL-CIO, speaking on behalf of unions that sponsored pension plans for millions of workers.
“In our opinion, the benefits to shareholders, lenders and the investing public from requiring rotation of auditors outweighs the additional cost that may be entailed in connection with a new auditor becoming familiar with the client,” Richard Trumka, then secretary-treasurer of the AFL-CIO, said in a 2001 letter to the SEC.166
Again, the industry fought back.
Testifying before the Senate Banking Committee in 2002 on behalf of the American Institute of Certified Public Accountants, James E. Copeland, Jr., who was chief executive of Deloitte & Touche, called mandatory rotation “a prescription for audit failure”:167
It would result in the destruction of vast stores of institutional knowledge and guarantee that auditors would be climbing a steep learning curve on a regular basis. It would expose the public to a greater and more frequent risk of audit failure. It would increase the likelihood of undetected fraud by management. It would make it easier for reckless management to mislead the auditor. And finally, it would allow companies to disguise opinion shopping by enabling them to portray a voluntary change in auditors as obligatory.168
Term Limits—The Shootdown of a Trial Balloon
A decade ago, under Chairman James R. Doty, the PCAOB issued a “concept release” on auditor independence — a sort of regulatory trial balloon — and held a series of public meetings to explore the subject.169 Doty identified auditing’s fundamental conflict of interest as an enduring problem.
“The inherent conflict presented by client pressures still weakens the commitment to investor protection,” Doty said in the text of a May 2012 speech to the American Institute of Certified Public Accountants, the industry’s main trade group.170
“This is the unfinished business that occupies the PCAOB, and I might add audit regulators around the world who have also identified a gap between the purpose of the audit and its fulfillment. This gap threatens the future relevance of the [audit] profession’s work, as well as public confidence in its credibility,” Doty said in the speech.171
Doty’s assessment was remarkable less for its substance than for its source: auditing’s lead U.S. regulator. As chairman of the PCAOB, Doty had special insight into the agency’s inspections of audit firms. He also had a special vantage point on how much regulators could and couldn’t accomplish under the current system.
At least one audit firm, Grant Thornton, seemed open to the idea of mandatory rotation.172 For Grant Thornton, term limits could create new opportunities. It could give second-tier firms more of a chance to compete with the Big Four audit firms that dominate audits of publicly traded companies.
The Big Four and many of their corporate clients rallied against term limits.173 They argued that requiring companies to periodically change audit firms would reduce the quality of audits, because audit firms face a steep learning curve when they take on a new company. One executive seemed to cast doubt on audits performed during the first few years of an audit firm’s tenure.
“The requisite level of knowledge cannot be effectively gained over a period of a few years. It is built over a much longer period of time,” Valarie L. Sheppard, who was senior vice president and comptroller of Proctor & Gamble, told the PCAOB.174
(Reacting to testimony by Sheppard and others, John C. Bogle, founder of The Vanguard Group, gibed, “They make an unbelievably powerful case that auditors should never be rotated. Never.”)175
Opponents of term limits also argued that companies would have difficulty rotating audit firms because there are so few options. Only four firms are big enough to audit multinational companies, they argued, and some of them could be disqualified from taking on the audit of a particular company because they already provide other services to the company. (Big accounting firms sell an array of consulting services.)
The opposition further argued that putting new teams in place around the world to audit a global company would be costly, difficult, disruptive, and time-consuming. They also argued that not all audit firms would have the industry-specific expertise to take on all clients.
Doty himself pointed out one of the ways mandatory rotation could fall short: Audit firms could protect each other — engage in mutual back-scratching — instead of serving as a check on each other’s work.176
There may be precedent for that. Before the PCAOB was created and tasked with inspecting audits of public companies, audit firms inspected each other under a system known as peer review. No major firm ever failed a peer review, and, in the midst of the Enron debacle, the Arthur Andersen firm passed a peer review by rival Deloitte.177
The risk of “I’ll scratch your back if you’ll scratch mine” would be heightened if, in the rotation as a particular company’s auditor, Audit Firm #1 could not only precede Audit Firm #2 but also follow it.
Richard Breeden, a former chairman of the SEC, questioned how much difference term limits would make if the terms were “reasonably long.”
“The guy who loses the audit in year two or three of a ten-year period is going to be just as disadvantaged internally in the firm as a person who might lose it in later years without rotation,” Breeden said. “Ultimately, rotation would replace one set of somewhat conflicted audit partners with another set of partners with exactly the same issue.”178
That might have been an unintended argument for shorter terms.
Breeden raised another issue. He warned that mandating rotation through regulatory action could be “challenged under the statutes requiring cost-benefit analysis.”179 In other words, it could be hard to marshal the economic data needed to show a court that benefits would outweigh costs.
That observation highlighted a Catch-22: If something has never been tried, it’s hard to prove what will happen if it’s tried.
Suggested alternatives to term limits included empowering a regulator to force a change of auditors if the incumbent were performing poorly, requiring companies to periodically put their audit out for competitive bids, requiring companies to periodically put more than one audit firm on the ballot for a binding shareholder vote,180 or giving companies a choice: either replace their audit firm periodically or, after a specified number of years, publicly justify keeping the incumbent.181
Those ideas seemed like weak substitutes for term limits, off-ramps from the road to major reform.
Supporters of term limits argued that the doomsaying about costs and disruptions defied their experience when companies changed auditors. Added costs, if any, would be modest in the scheme of things — especially compared to the money companies pay their CEOs.182
Further, the chance to win new clients formerly considered out of reach would prompt audit firms to develop any industry-specific expertise they might have been lacking, supporters argued.183
Charles A. Bowsher, a former comptroller general of the United States who spent 25 years in public accountancy, told the PCAOB that he had always been suspicious of the concerns that audit firms taking on a new client face a steep learning curve.184 But Bowsher pointed to a simple solution. During the final year of an audit firm’s term, a company could obtain overlapping audits: one by the outgoing audit firm, and another by the incoming firm. Large companies “can easily afford this,” Bowsher said.185
Advocates of mandatory rotation included Paul A. Volcker, the former Federal Reserve Board chairman.
Volcker died in 2019. But his stature as a financial statesman is not the only reason to give weight to the advice he gave the PCAOB in 2012. Ten years earlier, reportedly working for free, Volcker led an unsuccessful effort to overhaul and rescue Enron’s discredited auditor, the Arthur Andersen accounting firm.186 In addition, Volcker served as a director of a company that changed auditors. The new auditor found a lot of weaknesses in the work of its predecessor, Volcker recounted.187
“I understand why it makes an auditing firm perhaps uneasy to know that its term as auditor may be up and another firm is going to come and look over the work, but I think that is a useful point of uneasiness,” Volcker told the PCAOB.188
Volcker added that, when assessing term limits for auditors, the usual cost-benefit analysis doesn’t apply.
“What we’re worried about is a breakdown in the auditing process that leads to damage to the firm, may lead to the end of the firm, may lead to enormous reputational problems, which you can’t equate in any normal cost-benefit analysis. You have got a continuing stream of relatively small cost” — the audit fees — “with the risk of a huge catastrophe for the company. I don’t think that is susceptible to normal cost-benefit,” Volcker said.189
Getting away from the client-pays system and addressing the conflict-of-interest problem more directly “would be fundamentally important if you could do it,” Volcker said, “but I don’t know how.”190
Politically, the 2012 battle over mandatory rotation wasn’t a fair fight. As Berkeley’s Don Moore noted, those with a vested interest in the status quo mobilized to thwart change, while the countless, diffuse members of the public who stood to benefit from reform weren’t tuned in or aware of their stake in the matter.191
Ultimately, the House of Representatives passed a bill that would have prohibited mandatory rotation.192 The Senate did not follow the House’s example, and the bill did not become law, but the shot across the bow of the PCAOB seemed to have had the intended effect of killing the PCAOB’s initiative.193 The PCAOB adopted more incremental reforms.
It required audit firms to disclose to the PCAOB the name of the partner in charge of each public company audit,194 and it created a database disclosing that information to the public.195 It required audit firms to disclose in their audit reports how long they had been auditing the client.196 It also required auditors to identify in their reports so-called critical audit matters — issues that involved “especially challenging, subjective, or complex auditor judgment.”197 In other words, it required audit firms to provide a roadmap to where trouble might be lurking.
Term Limits and Their Limits — Looking Forward
Doty has stated in an oral history that he still thinks mandatory rotation has merit and that its day may come.
“It frames the limits of what is possible now,” Doty said in the April 2021 interview. “It is the ultimate way of limiting … the influence of the client payer model, and for that reason it may be one of the most important results for the auditing profession to come to in the fullness of time,” Doty said.198
Critics sympathetic to Doty’s effort have argued that term limits wouldn’t go far enough. They’ve argued that mandatory rotation would leave the fundamental conflict of interest intact: Audit firms would still work for their clients.
Professor John C. Coffee Jr. of Columbia Law School has written that mandatory rotation “is a necessary element in any package of reforms,” but it is insufficient and “no panacea.”199
“The danger, of course, is that if [corporate] management dominates the process, it may seek the most accommodating and deferential of the various candidates for the position of replacement auditor,” Coffee wrote.200
Mandatory rotation should be combined with other reforms designed to make auditors more accountable to investors, Coffee wrote. Shareholders representing, say, 10% of a company’s ownership should have the power to put an alternative auditor to a shareholder vote, and, to inform investors, an audit regulator should grade auditors on a curve showing how they compare, Coffee proposed.201
Coffee was writing for a U.K. audience, but his views apply in the United States as well.
In an email to POGO, Coffee cautioned that, once they hold stock in a company, many shareholders wouldn’t want to be told that the company’s financial statements are unreliable. They wouldn’t want the value of their shares to take a hit.202
Meanwhile, a lot has changed since companies like Procter & Gamble warned the PCAOB that it could be difficult to put big new audit teams in place for multinational corporations. It’s worth exploring how technological changes, such as the rise of Zoom and remote work, could ease transitions.
For mandatory rotation to work as intended, audit firms would need to know that their corporate client couldn’t fire them before their term is up. At least, not without cause — or intervention from the audit regulator.
Something would have to be done to prevent the incoming audit firm from simply hiring the same team of people who audited the company for the outgoing audit firm and keeping them on the job.
What’s more, audit firms would have to be prohibited from providing non-audit services, if only to eliminate the specific business relationships that would disqualify them from competing for many companies’ audits.
Eleanor Bloxham, who advises corporate executives and directors as head of The Value Alliance and Corporate Governance Alliance, sees mandatory rotation as part of a larger plan. It should be administered by a new, independent federal agency — not the PCAOB, and not the company being audited or members of its board of directors, Bloxham said in an email to POGO.203 In Bloxham’s vision, unlike the PCAOB’s leadership, the new federal agency’s board would have no ties to audit firms or companies.
“An entire system is required to achieve truly independent audits. One finger in the dike will not solve the problem,” Bloxham said.204
Tell the Truth
If the road to audit reform is otherwise blocked, there’s one simple step the government could take.
Don’t dilute auditors’ responsibilities or weaken the already weak “independence rules.”
But, at long last, for a change, tell the public the truth about audits.
Abandon the illusion or self-delusion and stop calling dependent auditors independent.
This report was supported in part by Luminate. In 2020, Luminate awarded the Project On Government Oversight a grant of $75,000 to build on POGO’s past investigative reporting about corporate auditing by diagnosing and explaining problems with the system, analyzing potential solutions, and promoting reform. This report is part of that ongoing work.
POGO is grateful to J. Edward Ketz for reviewing a draft of this report.
Sign up for our weekly newsletter!
Get a roundup of POGO's latest work and announcements. Delivered Saturday mornings.
Dale L. Flesher, Gary J. Previts, and Tonya K. Flesher, “The Life and Career of Colonel Arthur H. Carter; A Leading Accountancy Professional of the 1930s,” The CPA Journal, November 2020, https://www.cpajournal.com/2020/11/23/the-life-and-career-of-colonel-arthur-h-carter/.129
Shobhit Seth, “How The NYSE Makes Money,” Investopedia, updated March 31, 2020, https://www.investopedia.com/articles/investing/050515/how-nyse-makes-money.asp.130 Ronen includes this on the subject of stock exchanges hiring auditors: “Healy and Palepu … argue that stock exchanges, wanting to signal their reputations in competition for listing fees, have incentives to ensure that listed companies provide high-quality information to investors. They therefore suggest that the exchanges hire the audit firms, negotiate their fees, and oversee the outcome of the audits themselves. The exchanges could cover the audit fees through an increase in stock-trading fees, through additional listing fees, or a combination of the two.” Ronen, “Corporate Audits and How to Fix Them,” 202-203 [see note 55]. 131 Ronen, “Corporate Audits and How to Fix Them,” 205 [see note 55]. 132 Joshua Ronen, “Financial Statement Insurance,” Journal of Forensic Accounting 4, no. 1 (January-June 2003): 5, https://pages.stern.nyu.edu/~jronen/articles/Forensic_Accounting.pdf. 133 Ronen, “Corporate Audits and How to Fix Them,” 206 [see note 55]. 134 Email from Joshua Ronen to David Hilzenrath, March 23, 2022. 135 Lynn E. Turner, “Reforms of the Auditing Profession: Improving Quality Transparency, Governance and Accountability,” Harvard Law School Forum on Corporate Governance, December 28, 2020, https://corpgov.law.harvard.edu/2020/12/28/reforms-of-the-auditing-profession-improving-quality-transparency-governance-and-accountability/. 136 Turner, “Reforms of the Auditing Profession” [see note 135]; However, as professor John C. Coffee Jr. of Columbia Law School notes toward the end of this report, shareholders are not necessarily objective observers. With some exceptions, once investors hold shares in a company, they do not want to be told that the company’s financial statements are unreliable, because they don’t want the value of their shares to decline. Email from John C. Coffee Jr. to David Hilzenrath, March 22, 2022. 137 Lynn Turner interview with David Hilzenrath, April 13, 2022. 138 Sarbanes-Oxley Act of 2002, Pub. Law No. 107-204, 115 Stat. 2390 et seq. § 301, https://www.govinfo.gov/content/pkg/PLAW-107publ204/pdf/PLAW-107publ204.pdf. 139 Turner, “Reforms of the Auditing Profession” [see note 135]. 140 Lynn Turner interview with David Hilzenrath, May 5, 2022. 141 Michael Flaherman interviews with David Hilzenrath, January 20 and March 16, 2022. 142 Leslie Wayne, “Calpers, a Loud Corporate Critic, To Adopt System to Judge Itself,” New York Times, October 26, 1995, https://www.nytimes.com/1995/10/26/business/calpers-a-loud-corporate-critic-to-adopt-system-to-judge-itself.html; CalPERS, “Corporate Engagements,” accessed June 30, 2022, https://www.calpers.ca.gov/page/investments/corporate-governance/corporate-engagements; Jenny Anderson, “It’s Calpers-onal; Giant Pension Plan Flexing Its Financial Muscle,” New York Post, April 18, 2004, https://nypost.com/2004/04/18/its-calpers-onal-giant-pension-fund-flexing-its-financial-muscle/. 143 Joey Hilzenrath discussion with David Hilzenrath, March 26, 2022. 144 Competition & Markets Authority (U.K.), Statutory audit services market study: Final report (April 18, 2019): 187, https://assets.publishing.service.gov.uk/media/5d03667d40f0b609ad3158c3/audit_final_report_02.pdf. 145 Competition & Markets Authority (U.K.), Statutory audit services market study: Final report, 187 [see note 145]. 146 Department for Business, Energy, & Industrial Strategy (U.K.), Restoring trust in audit and corporate governance (March 2021), 147, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/970673/restoring-trust-in-audit-and-corporate-governance-command-paper.pdf. 147 Like the Project On Government Oversight, members of that group have received funding from Luminate to work on audit issues. The statement was coordinated under Luminate’s auspices. POGO was invited to co-sign it but declined. POGO issued an open letter of its own: Hilzenrath, “What the U.K. Can Learn from the U.S. Experience with Audit Reform” [see note 11]. 148 Greenpeace, et al., “Audit needs a major overhaul: the government’s plans are a good start,” accessed June 22, 2022, https://www.greenpeace.org.uk/wp-content/uploads/2021/07/Audit-Needs-a-Major-Overhaul.pdf. 149 EY, “Statement on the future of the EY Organization,” Press Release, September 8, 2022, https://www.ey.com/en_us/news/2022/09/statement-on-the-future-of-the-ey-organization. 150 Jean Eaglesham, “EY Faces Knotty Split of Its Lucrative Tax Business,” Wall Street Journal, September 20, 2022, https://www.wsj.com/articles/ey-faces-knotty-split-of-its-lucrative-tax-business-11663673562. 151 Public Company Accounting Oversight Board, Rules of the Board, Section 3: Auditing and Related Professional Practice Standards, Rule 3522: Tax Transactions, https://pcaobus.org/about/rules-rulemaking/rules/section_3. 152 Jesse Drucker, “Officials Balked at a Drug Company’s Tax Shelter. Auditors Approved It Anyway,” New York Times, July 7, 2022, https://www.nytimes.com/2022/07/07/business/perrigo-omeprazole-taxes-ey.html. 153 A person who did not want to be cited shared this point with POGO. 154 EY’s planned split seems to be mainly about maximizing consulting opportunities. According to the Wall Street Journal, EY’s leaders hope breaking up the firm “will free the consultants to win billions of dollars of new business, unfettered by independence rules that restrict the [consulting] work accounting firms can do for audit clients.” Jean Eaglesham, “Ernst & Young Leaders Expected to Approve Plan to Split Accounting Company,” Wall Street Journal, September 5, 2022, https://www.wsj.com/articles/ernst-young-leaders-expected-to-approve-plan-to-split-accounting-company-11662404933. 155 Securities and Exchange Commission, “SEC Charges General Electric With Accounting Fraud; GE Agrees to Pay $50 Million to Settle SEC's Charges,” Press Release 2009-178, August 4, 2009, https://www.sec.gov/news/press/2009/2009-178.htm; Securities and Exchange Commission, “General Electric Agrees to Pay $200 Million Penalty for Disclosure Violations” [see note 84]. Form 10-K for the Fiscal Year Ended December 31, 2020 (February 12, 2021), 55, https://www.sec.gov/Archives/edgar/data/40545/000004054521000011/ge-20201231.htm. 156 Hilzenrath, “Remember Enron? It Could Happen Again on Biden’s Watch” [see note 11]; Hilzenrath, “What the U.K. Can Learn from the U.S. Experience with Audit Reform” [see note 11]. 157 European Commission, “Reform of the EU Statutory Audit Market - Frequently Asked Questions (updated version),” June 17, 2016, https://ec.europa.eu/commission/presscorner/detail/en/MEMO_16_2244; The Statutory Auditors and Third Country Auditors Regulations (U.K.), 2017, https://www.legislation.gov.uk/uksi/2017/516/pdfs/uksi_20170516_en.pdf; Independent Regulatory Board for Auditors, “Rule on Mandatory Audit Firm Rotation,” 2017, https://www.irba.co.za/upload/Government%20Gazette%20with%20Final%20Rule%20-%201%20June%202017.pdf. 158 Maripat Brown, “Mandatory Audit Firm Rotation in the FTSE 350,” Audit Analytics, May 26, 2020, https://blog.auditanalytics.com/mandatory-audit-firm-rotation-in-the-ftse-350/. 159 Howard Schilit interview with David Hilzenrath, April 1, 2022. 160 Howard Schilit interview with David Hilzenrath, April 1, 2022. 161 Public Company Accounting Oversight Board, “Concept Release on Auditor Independence and Audit Firm Rotation; Notice of Roundtable,” PCAOB Release No. 2011-006, PCAOB Rulemaking Docket Matter No. 37, August 16, 2011, 10, https://pcaob-assets.azureedge.net/pcaob-dev/docs/default-source/rulemaking/docket037/release_2011-006.pdf. 162 Staff of Senate Committee on Government Operations, Subcommittee on Reports, Accounting, and Management, 94th Cong., Summary of The Accounting Establishment (Committee Print, December 1976), 19, https://www.sechistorical.org/collection/papers/1970/1976_1201_MetcalfSummaryT.pdf. 163 Staff of Senate Committee on Government Operations, Subcommittee on Reports, Accounting, and Management, 94th Cong., Summary of The Accounting Establishment, 19 [see note 162] 164 Commission on Auditors’ Responsibilities and Manuel F. Cohen, The Commission on Auditors’ Responsibilities: Report, Conclusions, and Recommendations (1978), [PDF p. 33 of 232] https://egrove.olemiss.edu/aicpa_assoc/433. 165 Public Company Accounting Oversight Board, “Concept Release on Auditor Independence and Audit Firm Rotation; Notice of Roundtable,” 11 [see note 161]. 166 Richard Trumka, secretary-treasurer of the AFL-CIO, to Jonathan G. Katz, secretary of the U.S. Securities and Exchange Commission, about “Request for Rulemaking Concerning Definition of Independent Auditor and Limiting Services Accounting Firms May Provide to Audit Clients,” December 11, 2001, https://www.sec.gov/rules/petitions/petn4-448.htm. 167 S. Hrg. 107-948, Accounting Reform and Investor Protection, Hearings before the Senate Committee on Banking, Housing, and Urban Affairs, Volume II, 107th Cong., (March 5, 6, 14, 19, 20, and 21, 2002), 821, https://www.govinfo.gov/content/pkg/CHRG-107shrg87708/pdf/CHRG-107shrg87708-vol2.pdf. 168 S. Hrg. 107-948, Accounting Reform and Investor Protection, Hearings before the Senate Committee on Banking, Housing, and Urban Affairs, Volume II, 107th Cong., 821, [see note 167]. 169 Public Company Accounting Oversight Board, “Concept Release on Auditor Independence and Audit Firm Rotation; Notice of Roundtable,” [see note 161]. 170 James R. Doty, “The Future of Financial and Business Reporting from a Standards-Setting and Regulatory Perspective,” (speech, 125th Anniversary of the American Institute of Certified Public Accountants, Washington, DC, May 17, 2012), https://pcaobus.org/news-events/speeches/speech-detail/the-future-of-financial-and-business-reporting-from-a-standards-setting-and-regulatory-perspective_405. 171 Doty, “The Future of Financial and Business Reporting from a Standards-Setting and Regulatory Perspective,” [see note 170]. 172 Grant Thornton to the Office of the Secretary of the Public Company Accounting Oversight Board, Comment on PCAOB Rulemaking Docket 037 [see note 32]. 173 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 169-172, 176, 187-190, 392, 397, 407-408, 414-415 [see note 3]. American Institute of CPAs to the Office of the Secretary of the Public Company Accounting Oversight Board, Comment on PCAOB Rulemaking Docket Matter No. 37 (December 14, 2011), https://pcaob-assets.azureedge.net/pcaob-dev/docs/default-source/rulemaking/docket037/413_aicpa.pdf; U.S. Chamber of Commerce to the Secretary of the Public Company Accounting Oversight Board, Comment on PCAOB Rulemaking Docket Matter No. 37 (October 20. 2011), https://pcaob-assets.azureedge.net/pcaob-dev/docs/default-source/rulemaking/docket037/033_chamber.pdf. 174 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012,181 [see note 3]. 175 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 238 [see note 3]. 176 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 320 [see note 3]. 177 Scot J. Paltrow, “Accounting Scandals Have Some Peering at Industry’s Self-Policing,” Wall Street Journal, January 14, 2002, https://www.wsj.com/articles/SB1010963336547708960; David S. Hilzenrath, “Andersen Passes Peer Review,” Washington Post, January 3, 2002, https://www.washingtonpost.com/archive/business/2002/01/03/andersen-passes-peer-review/9689dcf8-6011-4e6e-b777-105f0839a108/; The American Institute of Certified Public Accountants (AICPA), an industry group, maintains a peer review system for audits of private companies. American Institute of Certified Public Accountants, “Peer Review Home Page,” accessed June 22, 2022, https://peerreview.aicpa.org/; Going Concern reported in 2012 that, within the AICPA peer review program, Deloitte had become “the first Big 4 firm to have a non-clean report in the history of the Big 4.” Caleb Newquist, “Deloitte Achieves Another Unflattering Milestone in Audit Quality,” Going Concern, July 16, 2012, https://www.goingconcern.com/deloitte-achieves-another-unflattering-milestone-audit-quality/. 178 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 50-51 [see note 3]. 179 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 70 [see note 3]. 180 Staff of Senate Committee on Government Operations, Subcommittee on Reports, Accounting, and Management, 94th Cong., Summary of The Accounting Establishment (Committee Print, December 1976), 19, https://www.sechistorical.org/collection/papers/1970/1976_1201_MetcalfSummaryT.pdf. 181 Breeden discussed the first and third of these three alternatives. Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 52-53 [see note 3] 182 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012,, 274 [see note 3]. 183 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 340-341 [see note 3]. 184 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 37-38 [see note 3]. 185 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 39, [see note 3]. 186 Louis Uchitelle, “Enron’s Many Strands: Outsider’s View; Under Fire, Andersen Puts Trust In Volcker,” New York Times, February 4, 2002, https://www.nytimes.com/2002/02/04/business/enron-s-many-strands-outsider-s-view-under-fire-andersen-puts-trust-in-volcker.html. 187 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 32 [see note 3]. 188 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 33-34 [see note 3]. 189 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 67-68 [see note 3]. 190 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 76 [see note 3]. 191 Public Company Accounting Oversight Board, “Auditor Independence and Audit Firm Rotation, Public Meeting,” Transcript, March 21, 2012, 295 [see note 3]. 192 Audit Integrity and Job Protection Act., H.R. 1564, 113th Cong. (2013), https://www.congress.gov/bill/113th-congress/house-bill/1564. 193 SEC Historical Society, “James R. Doty - Oral History,” video, April 8, 2021, 18:43, https://www.youtube.com/watch?v=B-TVYFK0NYY. 194 Securities and Exchange Commission, “Public Company Accounting Oversight Board; Order Granting Approval of Proposed Rules to Require Disclosure of Certain Audit Participants on a New PCAOB Form and Related Amendments to Auditing Standards,” Release No. 34-77787, File No. PCAOB-2016-01, May 9, 2016, https://www.sec.gov/rules/pcaob/2016/34-77787.pdf. 195 Public Company Accounting Oversight Board, “AuditorSearch,” https://pcaobus.org/resources/auditorsearch. 196 Public Company Accounting Oversight Board, Staff Guidance; Changes to the Auditor’s Report Effective for Audits of Fiscal Years Ending On or After December 15, 2017 (updated December 28, 2017), 4, https://pcaobus.org/Standards/Archived/Documents/PCAOB-Auditors-Report-Guidance-12-28-17.pdf. 197 Public Company Accounting Oversight Board, The Auditor’s Report On An Audit of Financial Statements When The Auditor Expresses an Unqualified Opinion and Related Amendments to PCAOB Standards, PCAOB Rulemaking Docket Matter No. 034, PCAOB Release No. 2017-001 (June 1, 2017), 16, https://pcaob-assets.azureedge.net/pcaob-dev/docs/default-source/rulemaking/docket034/2017-001-auditors-report-final-rule.pdf. 198 SEC Historical Society, “James R. Doty - Oral History,” 19:35 [see note 193]. 199 John C. Coffee, “Why do auditors fail? What might work? What won’t?,” Accounting and Business Research 49, no. 5 (2019): 555, https://doi.org/10.1080/00014788.2019.1611715. 200 John C. Coffee, “Why do auditors fail” 555 [see note 199]. 201 Coffee, “Why do auditors fail?” 557 [see note 199]. 202 Email from John C. Coffee Jr. to David Hilzenrath, March 22, 2022. 203 Email from Eleanor Bloxham to David Hilzenrath, March 29, 2022. 204 Email from Eleanor Bloxham to David Hilzenrath, March 29, 2022.