November 28, 2011

PCAOB Finds Higher Deficiency Rates at Half of Big 4

From Lynn Turner: “Investors should be concerned by the two new PCAOB inspection reports released last week that indicate a significant increase in deficient audits performed by half of the Big 4 audit firms. As this Bloomberg Businessweek article notes, PWC had deficiencies in 37% of its audits examined and KPMG had deficiencies in 22% of its audits. These reports raise a question as to whether investors are getting value for the money being spent on audits – and they follow the recent report criticizing audits by Deloitte & Touche. Here is a letter from Senator McCaskill raising questions with respect to Deloitte audits.

It is interesting to note these reports no longer discuss which specific issuer had a restatement, but rather just note how many restatements there were. This is apparently a step backwards away from transparency, making it harder for readers to determine which issuers restated and rendering the reports of lesser value. Another unanswered question is how many, if any, of the audit partners involved have become the subject of PCAOB disciplinary actions.

The PwC report notes several recurring deficiencies in basic testing of a company’s revenues, internal controls and support for asset values. On these audits, there is not just one partner, but a second partner as well as an experienced manager. It really raises questions about the quality controls of the firm, given the high deficiency rate.

The KPMG report notes deficiencies in auditing allowances for loan losses, asset valuations, and internal controls. The reports highlight how auditors fail to test, or to test adequately, the value of assets such as investments, including testing the information received by pricing services. Deficiencies in such testing and deficiencies in pricing services processes were recently discussed at a PCAOB SAG meeting.

On some of these audits, the deficiencies cited raise a question about whether the audit committees are really overseeing the audits performed in a reasonable manner or merely going through the motions. It also appears that efforts by Congress, the business community and the SEC (under a prior Chairman) to “dumb down” audits of internal controls has worked, and the audits of internal controls may not hold a lot of value given the number of deficiencies noted.”

The UK’s “Forward-Looking Say-on-Pay” Proposal

It’s worth repeating this blog from Mark Borges from Saturday:

This past week, the United Kingdom High Pay Commission (an independent inquiry into executive compensation) released the results of its year-long study of executive pay. Entitled “Cheques With Balances: why tackling high pay is in the national interest,” the report includes 12 recommendations on ways to combat spiraling executive compensation.

The one that I found most interesting is the recommendation that the current shareholder advisory vote on executive compensation be made “forward-looking.” By this, the Commission means that shareholders would be given the opportunity to vote on a company’s proposed remuneration arrangements for the next three years (following the date of the vote). This would include future salary increases, bonus awards, and all ancillary benefits (such as pension arrangements).

As the Commission notes, this approach would give shareholders a genuine say in the remuneration to be paid to executives, not just the ability to “approve” or “ratify” the pay packages that have already been implemented. It almost goes without saying that this would be a radical departure from the current structure of shareholder advisory votes on executive pay (both in the UK and the US). Given that the concept of shareholder advisory votes originated in UK a mere decade ago, the proposal bears watching – if only to see how it is received in the UK corporate and investor communities.

More on “The Mentor Blog”

We continue to post new items daily on our blog – “The Mentor Blog” – for members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:

– Who “Owns” Your Social Media Policy?
– The Reality of Section 220 Claims for Books and Records
– Accounting That Comes in Flavors
– “Fifth Call” as Effective Means of Communication
– Department of State Speaks on Conflict Minerals

– Broc Romanek