Prepared Remarks by CAQ Executive Director Julie Bell Lindsay for the AICPA Conference on Current SEC and PCAOB Developments
Monday, December 7, 2020
The speech, Auditing in a Period of Transformation, covers auditing during COVID-19, the expanding role of auditors into new areas, and talent and diversity in the auditing profession.
I was recently thinking of my time at the Securities and Exchange Commission nearly twenty years ago. The Sarbanes Oxley Act had just passed, which gave the SEC a mandate to implement many new standards and rules.
When you entered the building, you could feel the palpable energy and sense of purpose created by these new responsibilities. Keep in mind, the US capital markets were still reeling from the extensive frauds discovered at Enron, Worldcom and others, frauds that had brought down one of the then “Big 5,” Arthur Anderson.
At the time, I was an eager, young securities lawyer in the Office of Rulemaking within the Division of Corporation Finance. While I was working on the final rules updating the Form 8-K current reporting requirements, a couple of my colleagues were working on the initial final rules to implement Section 404 of Sarbanes Oxley—the internal control over financial reporting provision.
I recall that the final 404 release was much longer than the final 8-K release. I also recall wanting to beat my colleagues to the sole printer in our office. I think our printer at the time had been purchased in 1934, when the SEC was established, as it printed a page about every 5 minutes.
The government’s technology and my lack of patience aside, I recall thinking the new internal control over financial reporting requirements – as well as the other provisions of Sarbanes-Oxley like management certifications – were going to transform trust in capital markets. And they did.
Sarbanes Oxley initiated a moment of transformation that runs through much of the way we report and audit financial information today. It was a game-changer.
I’m sharing this story about my time at the SEC, because I have the same feeling of transformation now that I had years ago. But unlike the transformation 20 years ago, the changes we are experiencing are not being forced on the profession as a result of corporate failures. Rather, the profession is responding to and – in some cases – leading the market in bringing about change.
What am I referring to? First, COVID-19 has required the profession to change and adapt to new circumstances and challenges in performing its public interest role. Second, auditing is changing as the role of the auditor expands into new areas like ESG, cyber risk management, and non-GAAP financial reporting. And, third, the profession is changing as a new generation of talent enters the work force, and a collective acknowledgment grows that we must prioritize and address increased diversity within our ranks.
These three forces together that I’ll talk about today are bringing about the biggest transformation to the audit profession and capital markets since the Sarbanes Oxley Act.
I’ll start by talking about COVID-19, because there is perhaps no change we feel more acutely today than the change brought on by the pandemic. Now, I want to take a quick poll to get a sense of what has changed the most for you during COVID-19. We’ll now activate the poll and you should see it appear momentarily, so go ahead and vote on what has been the most significant change for you during COVID-19. (Poll)
These are four changes resulting from the pandemic that we’re certainly seeing transform auditing and capital markets. First, new and complex accounting challenges are significant issues for both preparers and auditors. In fact, we’ve developed a set of resources to help financial reporting stakeholders navigate accounting challenges during the pandemic and they are one of the most viewed technical resources on our website.
Second, working remotely is something that accountants have really had to adapt to. I know I’ve been impressed by the way auditors quickly adapted to the remote environment – all while remaining laser-focused on audit quality. This quick adaptation has enabled auditors to continue to keep audit quality as their north star. Right now – particularly as we go into the year-end reporting season – that’s so important.
As the SEC said in April, “the proper functioning of our capital markets depends on a regular supply of high-quality financial information…” And the proper functioning of the capital markets is an essential component of our national response to, and recovery from, COVID-19.
Third, one of the ways auditors are maintaining audit quality is through new skills and technologies. Many have had to adapt to new technologies in the remote environment. I’m talking both about repurposing consumer technology like iPhones with location sharing and live video feeds used to conduct inventory observations but also the proliferation of automation and machine learning.
In many cases, this transition to automation has allowed auditors to move from sampling small subsets of relevant data to looking at larger swaths or even complete data sets. In specific cases, auditors apply technology like machine learning to evaluate documents for specific terms or phrases to more efficiently execute audits.
Technology can also help complete mundane and repetitive tasks. It allows the auditor to focus on more complex or unusual transactions, which may have a heightened risk of misstatement, including from fraud.
And fourth, I do want to talk about fraud for a moment, because COVID-19 has created new challenges for public companies that heighten the risk of fraud. Experts have already documented increases in financial statement fraud during the pandemic and they expect this trend to continue over the next several months.
In this heightened risk environment, there are three key points to keep in mind. First, there is no such thing as absolute assurance. Pursuant to US auditing standards, which is part of the strongest system for deterring and detecting fraud in the world, the auditor has a responsibility to obtain “reasonable assurance” that financial statements are free of material misstatement, whether caused by error or fraud. Put simply, auditing standards call for reasonable assurance; not absolute assurance.
Second, innovation is the best weapon in deterring and detecting fraud. Auditors are already innovating by using new technologies, like automation and machine learning that I mentioned earlier, to improve fraud deterrence and detection. Continued innovation will further improve our ability to fight fraud in the face of new challenges resulting from the pandemic.
Third, fighting fraud is a shared responsibility. The strongest fraud deterrence and detection requires extreme vigilance from all participants in the financial reporting system. This includes regulators, internal and external auditors, audit committees, and especially public company management. The Sarbanes-Oxley Act is clear that public company management is required to implement – and certify to – an effective system of internal controls over financial reporting to provide reasonable assurance that financial statements are free of material misstatements, including misstatements caused by fraud.
Audit committees of public companies also play an important role in deterring and detecting fraud. If an audit committee perceives there is a heightened fraud risk at their company, they are empowered to take additional action. For example, in their oversight role of the external auditor’s scope of work, audit committees can request forensic specialist involvement, a separate forensic audit, and additional fraud related procedures be performed during the audit. In this environment of heightened risk, audit committees should consider all of these options.
The Center for Audit Quality, as part of its Anti-Fraud Collaboration, is planning to release in January a detailed analysis of SEC accounting and auditing enforcement actions over the past several years.
The data identify specific areas that may be at a higher risk of fraud, but one thing is clear: fraud risk exists everywhere, and the factors that can lead to fraud are even more pronounced, or at risk, in the COVID-19 virtual environment. Fraud affects issuers of all sizes, in multiple jurisdictions, and across various industries. We must all remain vigilant during in this heightened fraud risk environment.
While the role of the auditing profession in deterring and detecting fraud is rooted firmly in the strongest financial reporting system in the world, the role of auditors in other areas is transforming.
The Expanding Role of Auditors
This brings me to the second force that’s contributing to the transformation of the audit profession and capital markets – the expanding role of auditors into new areas like ESG, cyber risk management, and non-GAAP financial reporting.
I want to now show a video about one area that’s getting a lot of attention – environment, social and governance reporting – and the role auditors can play – and are playing – in enhancing the reliability of this information.
We’re experiencing a watershed moment for ESG. Investors increasingly put money into funds comprised of public companies with strong ESG practices. With the increasing investor attention, public companies are ramping up communication around their sustainable business practices.
The need for this ESG information has increased due to COVID-19 and there is a surge of attention by companies on diversity as part of the quest for racial justice. Investors are suddenly seeking even more information and metrics around employee health, well-being, and diversity. Despite this trend, one of the biggest challenges to assessing a company’s ESG practices is the lack of broadly adopted ESG reporting standards.
The Center for Audit Quality recently conducted a qualitative research panel of senior ESG institutional investors who broadly agree that the comparability, reliability, and relevance of ESG information is a significant challenge. This contrasts significantly with the well-established standards that exist for reporting and evaluating a company’s financial performance.
While many investors in our research panel believe regulation is likely required to ensure fast, broad, and uniform adoption of ESG frameworks and standards, they also generally think regulators should leave the development of specific standards and frameworks to the market.
There was also broad agreement among investors that ESG information should be subject to third-party assurance, including auditing of “material” ESG information tied to a company’s financial performance. But for that to happen at scale, these investors want public companies to adopt consistent standards and frameworks.
We’ve seen a lot of momentum toward this goal. Leading framework and standard-setting bodies recently announced plans to collaborate on comprehensive ESG reporting. At the same time, the International Federation of Accountants called for the creation of a new sustainability accounting standards board that would exist alongside the International Accounting Standards Board. And, the IFRS Foundation issued a consultation in late September seeking comment on the advisability of doing just that. The Center for Audit Quality looks forward to commenting on that consultation.
Perhaps most importantly, public companies have already taken the next step and started to get auditor assurance of ESG information. Johnson & Johnson, Guess?, and Etsy are just a few well-known brands that are already getting auditor assurance.
These companies recognize that the public company auditing profession is steeped in the accountability, standards-based analysis and objectivity needed to review company-reported information – and these skills are transferable to ESG reporting. Put another way – like the audits of financial statements and internal control over financial reporting, third-party assurance from a public company audit firm enhances the reliability of information presented by companies to investors and other stakeholders.
This is a leading practice for companies committed to ESG, and I think we’ll see more companies move toward auditor assurance over the next year. This movement had already started to take hold. And, with the transformation of the profession’s role in both traditional and nontraditional financial information, we need auditors with new and different skills.
Talent and Diversity
This brings me to the third force that’s contributing to the transformation of the audit profession and capital markets – the next generation of talent. Bringing in diverse skills is the foundation of the multidisciplinary business model employed by auditing firms that has helped fuel improvements in audit quality over the past few decades.
We’re bringing in candidates with new skills, from data analysis and cybersecurity expertise to automation and machine learning. Attracting the next generation of talent is a top priority for the Center for Audit Quality.
In June of this year, we released a first of its kind career exploration documentary about the accounting and auditing profession titled – appropriately – “Making it Balance.” It’s an incredibly authentic and inspiring story of three diverse, young adults who take a road trip, in an RV, around the country to interview accounting and audit professionals. We’re going to play the trailer so you can judge it for yourself.
I love that trailer and I love the documentary. If you want to watch it online, you can check-out “Making it Balance” on the Center for Audit Quality website. I am confident that anyone who watches it will see a career in accounting in an entirely different light.
A few weeks ago, I had the pleasure of catching up with one of the documentary stars, Da’Rell Bratton, who is now working for PwC as new Assurance Associate in Houston. I reached out to him because I wanted to know why he choose a career in accounting over other professions. Here’s the video clip of him describing what attracted him to the profession.
If you know Da’Rell, you know he’s a people person, so it didn’t surprise me that working in teams was one thing that attracted him to auditing. Da’Rell is the type of person the public company auditing profession wants to recruit – someone who considers an exciting profession like sports marketing and then decides to become an auditor. In my book, auditing is equally exciting; many young professionals just don’t know it yet, and we need to change that.
The Center for Audit Quality Governing Board, which is comprised of leaders from eight of the largest public company auditing firms, sees the vital need to increase diversity within our profession. We all know that recruiting and advancing underrepresented talent is an area for improvement, especially when it comes to Black accountants. And, the increasing demand for social justice and equity has only magnified the need for change in this area.
For years, the number of Black CPA’s has remained stubbornly low. According to the AICPA’s most recent trends report, only 2% of all CPAs at US firms are Black and only 1% of partners at US firms are Black.
Our audit firm members are stepping up their efforts to help address the disparity. They’re creating anti-racism task forces. They’re committing millions of dollars to Historically Black Colleges and Universities to build-up the talent pipeline. They’re pledging millions of dollars to organizations that fight for social justice. And, they’re reviewing recruiting and retention practices to remove any bias that exists.
Another question I asked Da’Rell was how diversity in accounting impacted him as he was thinking about joining the profession. Here’s what he said.
Da’Rell is a force multiplier. He’s recruiting other diverse talent for the profession. So, if we can prioritize the hiring of talented, diverse professionals, it can help us recruit even more talented, diverse professionals. But to do this, we have to increase the number of underrepresented professionals, including Black professionals, in the pipeline.
While the firms have an important role to play in the diversity of the profession, they can’t do it alone. Diverse candidates too often encounter barriers even before they apply for an accounting job.
The Center for Audit Quality Governing Board and its member firms believe we need to pull all the levers available to us to promote diversity in the profession, and that includes removing unnecessary barriers.
One very real barrier is the cost associated with meeting the additional 30-hours in the 150-hour requirement to obtain a CPA license. With the additional 30 hours, we are asking young adults to pay for an extra year of school and delay entering the workforce to start earning a salary. That one-two punch can put a significant financial strain on young adults and deter them from entering the profession, especially the underrepresented and underserved.
As such, the Center for Audit Quality Governing Board chartered a multi-stakeholder working group to explore alternative means to meet the 30-hour requirement, beyond just academic credit – structured firm apprenticeships, as one example. The group includes representatives from academia, CPA state societies, the National Society of Black CPAs, NASBA and the AICPA.
Becoming a CPA is challenging. And it should be as a licensed profession. But making it challenging is different from maintaining unnecessary barriers to entry. Everyone should have a fair shot, regardless of means, or socio-economic status.
Allowing for greater flexibility and cost efficiencies for new talent entering the profession is challenging and will take time. But, we believe the payoffs of a deeper more diverse and representative talent pipeline is not only vital to our profession’s continued transformation – at this pivotal inflection point in our society, it’s also the right thing to do.
In conclusion, I’ve talked about COVID-19, the expanding role of the auditors, and recruiting the next generation of diverse talent – all forces transforming the auditing profession and capital markets.
While I recognize how this moment of transformation is similar to the moment of transformation during Sarbanes Oxley Act, there are some significant differences, as I alluded to at the start of my remarks. Twenty years ago, Sarbanes Oxley was passed into law to transform financial reporting in response to some high-profile failures. Today, we’re coming at this moment of transformation from a position of strength. Financial reporting and audit quality have never been stronger.
And, while legislators led the Sarbanes Oxley Act transformation, the accounting profession is in many ways leading the current transformation.
As a new president takes office and we enter a period of political transition and change, the accounting profession has never been in a stronger position to confront challenges and seize the opportunities before us.