Auditor Independence: A Focus on the SEC Independence Rules

Auditor independence is an important underpinning of the federal securities laws. These laws require that registrants' financial statements filed with the Securities and Exchange Commission (SEC) be audited by independent public accountants. The focus on independence for public company auditors was increased in light of the requirements of the Sarbanes-Oxley Act of 2002 to strengthen auditor independence. These instructional resources provide background information on the current SEC auditor independence rules. After becoming familiar with these rules, you will have the opportunity to complete several case scenarios that address: (1) hypothetical settings that may represent violations of the SEC independence rules, (2) possible actions that an audit committee might take when it determines that the SEC independence rules may have been violated, and (3) possible alternatives to the current SEC independence rules that could achieve the desired public policy goals of objective audits and investor confidence.

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Do Former Audit Firm Partners on Audit Committees Procure Greater Nonaudit Services from the Auditor?

The Accounting Review ◽

10.2308/accr-50271 ◽

2012 ◽

Vol 88 (1) ◽

pp. 297-326 ◽

Cited By ~ 31

Author(s):

Vic Naiker ◽

Divesh S. Sharma ◽

Vineeta D. Sharma

Keyword(s):

Audit Committee ◽

Auditor Independence ◽

Securities And Exchange Commission ◽

Data Availability ◽

Audit Committees ◽

Future Research ◽

Corporate Boards ◽

Audit Firm ◽

Sarbanes Oxley ◽

Nonaudit Services

ABSTRACT: To address potential threats to auditor independence, the Sarbanes-Oxley Act of 2002 (SOX) requires the audit committee to pre-approve nonaudit services (NAS) procured from the auditor. However, the presence of a former audit firm partner (FAP) affiliated with the current auditor on the audit committee could undermine the audit committee's due diligence over the NAS pre-approval process. To alleviate such concerns, the Securities and Exchange Commission approved a three-year “cooling-off” period for appointing audit firm alumni as independent directors. Our analyses show that the presence of both affiliated and unaffiliated FAPs on audit committees does not lead to greater NAS procured from the auditor; rather, FAPs reduce NAS procured from the auditor. Moreover, NAS decline significantly following the appointment of FAPs to the audit committee. Further tests suggest the three-year cooling-off period may not be warranted and deserves further investigation. Our study raises important implications for regulators, policy makers, corporate boards, and future research. Data Availability: Data are publicly available from sources identified in the text.

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The Effects of Prior Manager-Auditor Affiliation and PCAOB Inspection Reports on Audit Committee Members' Auditor Recommendations

Behavioral Research in Accounting ◽

10.2308/bria-51314 ◽

2015 ◽

Vol 28 (1) ◽

pp. 1-14 ◽

Cited By ~ 10

Author(s):

Lawrence J. Abbott ◽

Veena L. Brown ◽

Julia L. Higgs

Keyword(s):

Audit Committee ◽

Likert Scale ◽

Auditor Independence ◽

Publicly Traded ◽

Publicly Traded Companies ◽

Sarbanes Oxley ◽

Selection Decisions ◽

Public Company ◽

Auditor Selection ◽

One Year

ABSTRACT This study investigates (1) the extent to which audit committee members (ACM) of small publicly traded companies utilize Public Company Accounting Oversight Board (PCAOB) inspection reports in their auditor selection recommendations when management recommends hiring the auditor, and (2) whether the Sarbanes-Oxley Act's mandated one-year cooling-off period mitigates independence concerns of ACM resulting from a prior management-auditor affiliation in the same auditor selection context. We use financially literate professional participants as proxies for ACM who make a Likert-scale based recommendation for hiring the auditor. Our study manipulates a hypothetical, triennially inspected auditor's inspection results (favorable/unfavorable) as an auditor competence indicator and a prior management-auditor affiliation (present/absent) as an auditor independence indicator. We document that participants incorporate the inspection results into their selection recommendations, that prior affiliation negatively impacts ACMs' selection recommendations, and that auditor independence effects are contingent upon auditor competence. More specifically, auditor independence impacts auditor selection decisions only when auditor competence is favorable.

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The Effect Of Auditor Independence On International Capital Markets For eCommerce Firms

Journal of Business & Economics Research (JBER) ◽

10.19030/jber.v1i2.2972 ◽

2011 ◽

Vol 1 (2) ◽

Author(s):

Thomas J. Tribunella ◽

Heidi R. Tribunella

Keyword(s):

Capital Markets ◽

Business Models ◽

New Technologies ◽

Financial Statements ◽

Efficient Market Hypothesis ◽

Auditor Independence ◽

Securities And Exchange Commission ◽

Information Value ◽

Font Size ◽

Sarbanes Oxley

According to the efficient market hypothesis, the market for securities can be described as efficient if the market reflects all available information and reacts quickly to new information (Schroeder and Clark 1998).  Investors depend on financial statements to help them judge opportunities, risks, and investment alternatives (Revsine, Collins and Johnson 1999).  This information must be verified by independent sources such as auditors.  The relationship between auditor and stockholder is based on agency theory (Schroeder and Clark 1998), where the agent (auditor) has a fiduciary relationship with the principle (stockholders).  Any loss of faith in auditor independence by investors will seriously affect the information value of financial statements. Auditor independence rules must be easy to understand and rigorously enforced or the public's confidence in financial statements will erode.  This paper will specifically assess the difficulties encountered by large accounting firms such as PriceWaterhouseCoopers (PWC) and Arthur Andersen  in their efforts to remain independent with respect to their e-commerce clients.  Many e-commerce companies have innovative and untested business models as well as inexperienced and untraditional business managers.  Some auditors fail to measure the risk associated with these intangible, knowledge-based attributes.  In addition, auditor independence may be blurred by the promise of lucrative consulting contracts.  According to Arthur Levitt, the Chair of the SEC in 1999: “The dynamic nature of today’s capital markets creates issues that increasingly move beyond the bright line of black and white.  New industries, spurred by new services and new technologies, are creating new questions and challenges that must be addressed.  Today, we are witnessing a broad shift from an industrial economy to a more service based one; a shift from bricks and mortar to technology and knowledge.” (Levitt 1999) The objective of this paper is to review current independence rules, assess the difficulty in maintaining independence in the current e-commerce environment, and to make suggestions for improving independence rules.  In addition, investigations conducted by the Securities and Exchange Commission (SEC) and new legislation such as the Sarbanes-Oxley Act will be reviewed as possible solutions to the problem.

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The Effects of Manager-Auditor Affiliation and PCAOB Inspection Reports on Audit Committee Members' Auditor Selection

Current Issues in Auditing ◽

10.2308/ciia-51611 ◽

2016 ◽

Vol 11 (1) ◽

pp. P1-P10 ◽

Cited By ~ 2

Author(s):

Veena L. Brown

Keyword(s):

Audit Committee ◽

Auditor Independence ◽

Audit Committees ◽

Public Companies ◽

Sarbanes Oxley ◽

Management Measures ◽

Selection Decisions ◽

Public Company ◽

Selection Decision ◽

Auditor Selection

SUMMARY This article summarizes the “The Effects of Prior Manager-Auditor Affiliation and PCAOB Inspection Reports on Audit Committee Members' Auditor Recommendations” (Abbott, Brown, and Higgs 2016), who investigate the extent to which audit committee members (ACM) of small public companies consider auditors' Public Company Accounting Oversight Board (PCAOB) inspection reports and/or the auditors' prior affiliation with management in their auditor hiring decisions. The authors find participants (the study's proxy for ACM) incorporate the inspection report, as well as the auditor's prior affiliation with management into their selection decision. Specifically, an auditor's prior affiliation with management negatively impacts his/her chances of being selected by the audit committee. To the extent inspection results measure auditors' competence and prior affiliation with management measures auditor independence, the authors find auditor independence influences auditor selection decisions only when an auditor is deemed competent. In this paper, I discuss the implications of Abbott et al.'s (2016) findings for auditors, public companies, audit committees, and regulators/policymakers interested in understanding whether and how major aspects of the Sarbanes-Oxley Act of 2002 are being implemented within corporate governance.

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The PCAOB Meets the Constitution: The Supreme Court to Decide on the PCAOB’s Conformity with the Separation of Powers Doctrine and Appointments Clause

Accounting Horizons ◽

10.2308/acch.2010.24.1.79 ◽

2010 ◽

Vol 24 (1) ◽

pp. 79-93 ◽

Cited By ~ 5

Author(s):

Ronald R. King

Keyword(s):

Supreme Court ◽

Separation Of Powers ◽

Securities And Exchange Commission ◽

Point Of View ◽

Board Members ◽

Non Profit ◽

Sarbanes Oxley ◽

Public Company ◽

The Future ◽

Accounting Standard Setting

SYNOPSIS: This commentary provides an overview of the case currently before the U.S. Supreme Court that alleges constitutional problems with the Public Company Accounting Oversight Board (PCAOB). The PCAOB, a Board designed to oversee auditing for publicly traded firms, was created by Congress when it passed the Sarbanes-Oxley Act of 2002 (hereafter, SOX). To enhance PCAOB’s independence from political pressures, Congress established it as a private-sector, non-profit organization, and gave oversight powers to the Securities and Exchange Commission (hereafter, SEC), an independent agency. The plaintiffs in this case allege that Congress empowered the PCAOB with broad executive powers, yet limited the President’s ability to appoint Board members (thus violating the appointments clause of the Constitution) and to control and/or remove Board members (thus violating the separation of powers doctrine of the Constitution). The Supreme Court’s decision about the constitutionality of the PCAOB is important because of its potential impact on (1) the future of auditing oversight; (2) the validity of SOX; and (3) the future of independent agencies in general. From a policy point of view, the case highlights the importance of the combination of independence and accountability for auditing and accounting standard setting and practice.

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An Analysis of SEC and PCAOB Enforcement Actions against Engagement Quality Reviewers

Auditing A Journal of Practice & Theory ◽

10.2308/aud.2010.29.2.233 ◽

2010 ◽

Vol 29 (2) ◽

pp. 233-252 ◽

Cited By ~ 28

Author(s):

William F. Messier ◽

Thomas M. Kozloski ◽

Natalia Kochetova-Kozloski

Keyword(s):

Securities And Exchange Commission ◽

Future Research ◽

Audit Process ◽

Accounting Firms ◽

Professional Skepticism ◽

Quality Review ◽

Sarbanes Oxley ◽

Big 4 ◽

Public Company ◽

Quality Control Mechanism

SUMMARY: Engagement quality review is an integral part of the audit process. It is designed to be a quality control mechanism for assessing the quality of an audit engagement. Since the 1990s, the Securities and Exchange Commission (SEC) has increased sanctions against partners serving as engagement quality reviewers. Recently, the Public Company Accounting Oversight Board (PCAOB) issued an auditing standard on engagement quality review as required by Section 103 of the Sarbanes-Oxley Act of 2002. This practice note reports on an analysis of SEC and PCAOB enforcement actions against engagement quality reviewers (EQRs). Our results show the following: We identified 28 cases since 1993 that involve some type of sanction against an EQR. Only eight cases involved the Big 4/5 public accounting firms. All of the 28 cases involved sanctions due to violations of GAAS and 75 percent contained GAAP violations. Twenty-three cases identified GAAS violations related to a lack of due professional care. Further analysis of those cases showed that the EQR demonstrated a lack of professional skepticism in 22 cases, over-relied on management representations in 20 cases, and ignored materiality concerns in five cases. About half of the 28 cases resulted in the EQR being denied the privilege of practicing before the SEC or PCAOB for three or more years. Our findings provide important implications for practitioners and regulators, and areas for future research for those interested in engagement quality review.

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Public Accountants’ Perceptions Of The Acceptability Of Earnings Management Practices Through The Employment Of GAAP In The Post-Sox Period

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v26i1.277 ◽

2010 ◽

Vol 26 (1) ◽

Cited By ~ 1

Author(s):

John E. McEnroe

Keyword(s):

Earnings Management ◽

Management Practices ◽

Financial Statements ◽

Securities And Exchange Commission ◽

Font Size ◽

Generally Accepted Accounting Principles ◽

Sarbanes Oxley ◽

Accounting Scandals ◽

Audit Opinions ◽

Certification Requirements

Over fifteen years ago, Martens and McEnroe (1992) conducted a behavioral study involving earnings management through the use of Generally Accepted Accounting Principles (GAAP). Their findings indicated that auditors issued unqualified audit opinions on those financial statements and perceived little risk to litigation as a result. A decade later they conducted a similar study (Martens and McEnroe 2002) with the expectation that increased attention to earnings management by then chairman of the Securities and Exchange Commission (SEC), Arthur Levitt, would reduce auditors’ perceptions that the letter of GAAP is in itself an aegis or “safe harbor” against litigation. Although the authors found that auditors had become more conservative, they still issued unqualified opinions on financial statements in which transactions were reported in their form rather than their substance. Given the accounting scandals of Enron and WorldCom, among others, and the enactment of the Sarbanes-Oxley Act (SOX) in 2002, especially with its officers’ certification requirements, it was posited that auditors would exhibit a much more conservative approach than in either of the two previous studies. The results indicate that although auditors are more conservative than in the 1992 study, they still allow clients to engage in earnings management practices through the use of GAAP by issuing unqualified audit opinions on their financial statements.

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A Review Of Going Concern Prediction Studies: 1976 To Present

Journal of Business & Economics Research (JBER) ◽

10.19030/jber.v5i5.2541 ◽

2011 ◽

Vol 5 (5) ◽

Cited By ~ 7

Author(s):

Jodi L. Bellovary ◽

Don E. Giacomino ◽

Michael D. Akers

Keyword(s):

Model Development ◽

Probit Analysis ◽

Securities And Exchange Commission ◽

Logit Analysis ◽

Font Size ◽

Primary Methods ◽

Going Concern ◽

Sarbanes Oxley ◽

Public Company ◽

Going Concern Opinion

In 1962, the Securities and Exchange Commission (SEC) was the first to address going concern issues with Accounting Series Release (ASR) No. 90.   Then, in 1963, the AICPA issued Statement on Auditing Procedures (SAP) No. 33, in response to ASR No. 90.  Both ASR No. 90 and SAP No. 33 addressed qualifications for issues that were unresolved and the results of which were indeterminable at the statement date. Soon after the issuance of Statement on Auditing Standards (SAS) No. 2 in 1974, researchers began to conduct studies on going concern issues.  This paper provides a comprehensive review of the literature on going concern studies and updates studies by Mutchler (1983) and Asare (1990) which provide detailed reviews of the evolution of the going concern report and requirements of the standards related to auditors' assessment of going concern.  Since SAS No. 2, the profession has not provided additional guidance on going concern.  Even the Sarbanes-Oxley Act of 2002 (SOX), makes no modifications to the requirements for considering going concern and the Public Company Accounting Oversight Board has not issued guidance addressing going concern. Starting with the first going concern prediction study [McKee, 1976], this paper identifies 27 models developed for predicting the going concern opinion and identifies the primary methods used for model development; multivariate discriminant analysis (MDA), logit analysis, probit analysis, and neural networks are.  This paper also identifies; the most popular type of focused model and identifies three non-U.S. firm models, the number of factors considered in any one study,  and the predictive abilities of the models. The paper also provides an annotated bibliography for the 27 models.

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Comments by the Auditing Standards Committee of the Auditing Section of the American Accounting Association on PCAOB Release No. 2016-003, Proposed Auditing Standard—The Auditor's Report on an Audit of Financial Statements when the Auditor Expresses an Unqualified Opinion and Related Amendments to PCAOB Standards

Current Issues in Auditing ◽

10.2308/ciia-51651 ◽

2016 ◽

Vol 11 (1) ◽

pp. C26-C40 ◽

Cited By ~ 1

Author(s):

Marcus M. Doxey ◽

Stephen H. Fuller ◽

Marshall A. Geiger ◽

Willie E. Gist ◽

Karl E. Hackenbrack ◽

...

Keyword(s):

Financial Statements ◽

Auditor Independence ◽

Data Availability ◽

Financial Statement ◽

Specific Information ◽

Reporting Standard ◽

The Public ◽

Auditor Tenure ◽

Public Company ◽

Auditor Reporting

SUMMARY On May 11, 2016 the Public Company Accounting Oversight Board (PCAOB) issued a request for comment on Proposed Auditing Standard—The Auditor's Report on an Audit of Financial Statements when the Auditor Expresses an Unqualified Opinion and Related Amendments to PCAOB Standards, a reproposal of its August 2013 proposed auditor reporting standard. The reproposal retains the pass/fail model of the existing auditor's report while seeking to enhance the form and content of the report. The reproposal solicited public comment on the following significant changes to the existing auditor's report: (1) add a description of “critical audit matters” that provides audit-specific information about especially challenging, subjective, or complex aspects of the audit as they relate to the relevant financial statement accounts and disclosures, (2) add a statement about auditor independence and the phrase “whether due to error or fraud” when describing the auditor's responsibilities to obtain reasonable assurance about whether the financial statements are free of material misstatements, (3) add a statement related to auditor tenure, and (4) standardize the form of the auditor's report, requiring the opinion be the first section of the auditor's report and requiring section titles to guide the reader. The comment period ended on August 15, 2016. This commentary summarizes the participating committee members' views on the alternatives presented in the request for comment. Data Availability: The concept release, proposed and reproposed rules, and supplemental information are available at: http://pcaobus.org/Rules/Rulemaking/Pages/Docket034.aspx

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Auditing Issues with Chinese Reverse Merger Companies Traded in the United States

International Journal of Accounting and Financial Reporting ◽

10.5296/ijafr.v2i2.2187 ◽

2012 ◽

Vol 2 (2) ◽

pp. 76

Author(s):

Frederic M. Stiner ◽

Susan A. Lynn

Keyword(s):

United States ◽

Audit Quality ◽

The United States ◽

Auditor Independence ◽

Securities And Exchange Commission ◽

Future Research ◽

Chinese Government ◽

The Public ◽

Reverse Mergers ◽

Public Company

Recently there have been two issues related to Chinese companies seeking capital in the United States. The first issue is frauds that have been perpetrated by companies using reverse mergers in order to go public. The second issue is fraud in continuing audit engagements when there has been reliance by an American audit firm on a foreign accountant’s audit work. There is also conflict between the Public Company Accounting Oversight Board (PCAOB) demanding to inspect audit workpapers for companies in China and the Chinese government’s refusal to let the PCAOB see these workpapers. These issues relate to characteristics of the practice of accounting and auditing in China that threaten auditor independence and audit quality. The paper discusses: (1) issues involving reverse mergers and the response of the Securities and Exchange Commission (SEC) to these issues, (2) issues involving reliance on the work of foreign Certified Public Accountants (CPAs) and the response of the PCAOB to these issues, (3) issues involving conflicts between U.S. regulatory agencies and the Chinese government over access to audit-related documents, and (4) suggestions for future research.

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