The PCAOB recently noted that during 2019 it will provide an opportunity for audit committee chairs of certain companies whose audits are subject to inspection to “engage in a dialogue with the inspections staff.” While we assume the PCAOB’s motive is in good faith to obtain a better mutual understanding of the PCAOB process on one hand and the audit committee process on the other, the dialogue may be a gateway to enforcement activity.
Accordingly, we believe issuers should approach any such engagement cautiously, if at all. Perhaps the only circumstance for which this may be appropriate is upon assurance by the PCAOB that the inspection of the issuer is complete and final and no potential deficiencies were identified. Even then, issuers should consider whether there is any benefit to the dialogue. It is especially worth consideration because the PCAOB also announced it intends to publish additional updates to audit committees regarding its inspections including observations from these interviews and its inspection findings.
Why? Inspection findings can lead to restatements and potential liability for companies. Even if there are no findings, issuers will not have any control over how the PCAOB reports the results of its interviews to the public. There is a risk that audit committee chairs or issuers could be cast in a negative light.
Additionally, inspections are the root of many PCAOB enforcement actions. While the PCAOB’s Division of Enforcement and Investigations, or DEI, only has the authority to act against auditors (at present), it is DEI’s practice to share investigative results with government enforcement agencies, including those who have the authority to bring actions against issuers. Such “engagement” could become the route by which the PCAOB obtains statements from audit committee chairs that are shared with and used by DEI without causing DEI first to obtain an SEC subpoena.
So, what should issuers do if the PCAOB wants to talk to their audit committee chair or if issuers otherwise become aware that their audit has become subject to inspection and deficiencies have been noted?
Issuers should include a requirement in their audit engagement letters that the auditor must (within 14 days) reveal to the company if: (i) the PCAOB selects one of their audits for inspection, (ii) the issuer is the subject of an investigation, or (iii) the issuer otherwise becomes connected to an inquiry from the PCAOB or the SEC. While perhaps more controversial, issuers should also consider including a requirement that the work papers of the auditor will be shared with or available to the issuer if there is a triggering event such as selection of an audit for inspection by the PCAOB. If the conduct of the issuer is questioned as part of the inspection, or if the inspection could result in a restatement, the issuer or perhaps its audit committee should retain counsel to conduct a privileged internal investigation. Counsel should then retain a forensic auditor to assist in the investigation in a privileged manner.
We believe that counsel for the company or the audit committee is the proper person to engage with the PCAOB. If an audit committee member is invited in by the PCAOB’s Director of Registration and Inspections for some “engagement,” she or he may want to bring counsel along, or first send counsel in her or his place to get a preview. Alternatively, to keep the engagement on a narrowly defined track, counsel should request that the PCAOB submit its questions in writing and work with the issuer to provide its response in writing through counsel followed by a subsequent phone call with the PCAOB to resolve any open questions.
Note: Joel Schwartz, a partner with Stinson Leonard Street LLP, is a former assistant director of enforcement at the PCAOB. Steve Quinlivan, Bryan Pitko and Jaclyn Schroeder practice with Stinson’s Corporate Finance Division and regularly represent public companies.