Government Regulation of Accountants: The PCAOB Enforcement Process

ABSTRACT In 2002 the federal government altered the landscape of the accounting profession by creating, for the first time, a federal regulatory agency for this profession: the Public Company Accounting Oversight Board (PCAOB). Congress responded to the massive corporate failures of Enron, Tyco and others by enacting the Sarbanes-Oxley Act (SOA), to improve corporate governance and the reliability of financial information. Sarbanes-Oxley created the PCAOB to oversee the work of public accountants, the creators of corporate financial information. The purpose of this paper is to provide insight and understanding into the PCAOB's enforcement process. This is important to public accounting students and practitioners. By gaining insight into how and why the PCAOB regulates as it does, needless conflict can be avoided and a constructive, mutually beneficial relationship will likely ensue. This paper begins with an overview of government regulation, in order to show how the PCAOB fits into the general context of regulation. Then we review the Sarbanes-Oxley Act, which created the PCAOB. Next we consider the PCAOB, noting its unique features. The paper then describes and analyzes the PCAOB's enforcement mechanisms. Finally we conclude with recommendations as to how accountants can most constructively interact with the PCAOB. INTRODUCTION When President Bush signed the Sarbanes-Oxley Act (SOA) (1) in 2002 he stated that it created "the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt" (2). The SOA was a federal response to the massive corporate failures of Enron, Tyco and others. These failures were caused, in part, by accounting failures that had misrepresented the financial condition of some corporations. When the truth came out these corporations collapsed, causing losses to investors estimated at between $300 billion (3) and $500 billion (4). Investor confidence in our capitol markets was shaken. In order to restore that confidence, and to make financial information more reliable, Congress passed the SOA by an overwhelming majority: 423 to 3 in the House of Representatives, and 99 to 0 in the Senate (5). Accounting failures contributed to the recent crisis in investor confidence, but they were not the only cause of it. Some corporate managers contributed by "cooking the books" in order to increase stock prices so that they could collect inflated performance-based bonuses and profit from their stock options. Some securities analysts contributed by touting questionable securities because their broker-employers were selling them. And some public accounting firms contributed by performing substandard audits because they were not sufficiently independent and because they did not want to lose profitable non-audit business (6). Add to this mix the bursting of the tech stock bubble, and a perfect storm of shaken investor confidence ensued. Sarbanes-Oxley attempts to correct the various causes of this post-Enron crisis in confidence. To improve corporate governance, new independence requirements were established for corporate board audit committees; new internal control systems were mandated; corporate loans to management were prohibited; new attestation statements and signatures (7) by Chief Executive Officers (CEO)s and Chief Financial Officers (CFO)s were required for reports to the Securities Exchange Commission (SEC); and penalties for fraud were increased. Securities analysts' conflicts of interest were addressed by requiring a wall of separation between the sales staff of a brokerage firm and its analysts, and by prohibiting a brokerage firm from punishing an analyst who issued a negative report on a security. Analysts were also required to disclose their own holdings of the securities they were reporting on. But the most sweeping changes wrought by Sarbanes-Oxley were reserved for public accountants. …